Stability breeds instability – the Minsky Moment

I have shown my classes the documentary ‘Inside Job’ and the movie ‘The Big Short’ both about the 2007 global financial crisis (GFC). The GFC is often described as a Minsky Moment named after economist Hyman Minsky.

Minsky explored how financial crises arise after prolonged periods of stability that obscure underlying risks. This concept highlights that during extended bullish speculation, investors may overlook accumulating risks, which eventually trigger a severe crisis. In 1998 Paul McCulley, an American economist, used the term when observing the Asian Debt Crisis of 1997. He emphasised that the longer speculative trends persist, the more profound the subsequent crisis tends to be.

Minsky was a Keynesian, arguing that markets tend to produce crises that good institutions and policies can prevent. Minsky believed that financial markets move through cycles of boom and bust, emphasising that once there’s a transition from stable investment to speculative finance, the chance for a crash heightens when the time comes that investors can no longer afford their spiraling debt. However, debt isn’t inherently bad; it’s useful when used wisely for productive investments. Problems occur when it’s misused.

Minsky described three stages in the credit cycle that leads to a Minsky Moment – see graphic.

“The hedge finance stage: Borrowers can repay their debts with revenue or cash on hand. They have enough cash flow to cover both the principal and interest on their loans.

“The speculative finance stage: Borrowers can still pay interest on their loans but must continually roll over the principal. They rely on the hope that they can refinance or borrow new funds to cover their principal.

“The Ponzi finance stage: Borrowers can only repay their debts by increasing their debt. Borrowers don’t have enough cash coming in to cover either the principal or interest payments on their loans. They can now only rely on the appreciation of their assets or the willingness of lenders to provide additional funding.

“Once an economy reaches the third stage, if prices don’t go up and lenders stoplending, then the Minsky moment arrives.”

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