What is a Minsky Moment?

Minsky Moment refers to the onset of a market collapse brought on by the reckless speculative activity that defines an unsustainable bullish period. Minsky Moment is named after economist Hyman Minsky and defines the point in time where the sudden decline in market sentiment inevitably leads to a market crash.

Key Takeaways

  • Minsky Moment refers to the onset of a market collapse brought on by the reckless speculative activity that defines an unsustainable bullish period.
  • Minsky Moment crises generally occur because investors, engaging in excessively aggressive speculation, take on additional credit risk during bull markets.
  • Minsky Moment defines the tipping point when speculative activity reaches an extreme that is unsustainable, leading to rapid price deflation and unpreventable market collapse.

Understanding Minsky Moment

A Minsky Moment is based on the idea that periods of bullish speculation, if they last long enough, will eventually lead to crisis, and the longer the speculation occurs, the more severe the crisis will be. Hyman Minsky's main claim to economic theory fame was centered around the concept of inherent instability of markets, especially bull markets. He felt that extended bull markets always end in epic collapses.

Minsky postulated that an abnormally long bullish economic growth cycle will spur an asymmetric rise in market speculation that will, eventually, result in market instability and collapse. A Minsky Moment crisis follows a prolonged period of bullish speculation which is also associated with high amounts of debt taken on by both retail and institutional investors.

The term Minsky Moment was coined in 1998 by Paul McCulley, of PIMCO fame, while referring to the Asian Debt Crisis of 1997. A dissection of the causes that led to this crisis put the preponderance of blame on speculators putting increasing pressure on dollar-pegged Asian currencies until they eventually collapsed.

Perhaps the most famous, or at least the most recent, crisis that brought Minsky Moment to the forefront, if for no other reason than as an example of the dangers of profligacy, was the 2008 financial crisis, also called the Great Recession. During the height of this crisis, a wide range of markets reached all-time lows, triggering a wave of margin calls, a massive selloff in assets to cover debts, and higher default rates.

Minsky Moment Catalysts and Effects

Minsky Moment crises generally occur because investors, engaging in excessively aggressive speculation, take on additional credit risk during prosperous times, or bull markets. The longer a bull market lasts, the more investors borrow to try and capitalize on market moves. Minsky Moment defines the tipping point when speculative activity reaches an extreme that is unsustainable, leading to rapid price deflation and unpreventable market collapse. What follows, as hypothesized by Hyman Minsky, is a prolonged period of instability.

As a hypothetical example, consider a market in the throes of a bullish surge that sees investors borrowing funds aggressively, often to the limits of their capabilities, to participate in the economic boom. If the market retraces slightly, which is normal market behavior, their leveraged assets valuations could decrease to the point where they might not cover the debts taken to acquire them. Lenders start calling in their loans. Speculative assets are hard to sell, so investors are forced to sell less speculative ones to satisfy the lender's demands. The sale of these investments causes an overall decline in the market. At this point, the market is in a Minsky Moment. The demand for liquidity might even force the country's central bank to intervene.

Is Another Minsky Moment Looming?

In 2017, several experts issued warnings of an approaching Minsky Moment in China as debt levels increased while equity market valuations maintained their bullish trend. The Chinese government has also issued warnings to investors of an impending Minsky Moment if debt levels continue to rise.

Meanwhile, the International Monetary Fund (IMF) joined the chorus in issuing global warnings of high debt levels that had the potential to result in Minsky Moment crises around the world. While this has not come to fruition yet, the warning signs are there. The U.S. has been experiencing an extended period of economic prosperity, debt levels are rising, and speculative activity is robust, although it does not appear to have reached the extreme levels that presage a Minsky Moment.