Stock Market: Minsky Moments
Table of Contents

Minsky Moments

Hyman Minsky is most famous for the idea that

stability is unstable

Periods of economic stability encourage investors into taking on more risk because volatility is low. This leads them to borrow excessively and to overpay for assets. Minsky suggested three main types of borrower, increasingly risky in nature:

  • Hedged borrowers, who can meet all debt payments — interest and principal repayment — from their cash flows
  • Speculative borrowers, who can meet their interest payments, but can only repay principal when the asset is sold
  • Ponzi borrowers, who can’t pay the interest, let alone the original debt, and rely entirely on rising asset prices to allow them continually to refinance their debt

The Ponzi borrowers are:

  • Anyone borrowing against their property on a teaser rate — a low rate which carries a prepayment penalty — or a negative-amortization loan. Or who simply has bought or held on to property that they do not have the cash flow to carry, but must sell fairly quickly.
  • The leveraged hedge funds — and people borrowing to invest in them
  • Many stock traders using margin. Corporate dividend yields are way below margin rates so the margin borrower is burning money with net carry in his or her account

For example, Wall Street needed mortgage securities to sell in 2003, but most of the people who already owned homes had already refinanced to the lowest rates possible, thanks to the Fed's 1% rate policy. Thus they targeted a different market: the sub-prime market. In this environment, Warren Buffett noted that securitizing uneconomic mortgages didn't make any sense: I don't see any way that pooling a bunch of mortgages, changing the ownership, is going to change the viability of the mortgage instrument itself — whether people can make the payments. It should be impossible to have a profitable business lending money to people who can't pay you back (Richard Gibbons, January 2008)

The longer a period of economic stability lasts, the more society moves towards being full of Ponzi borrowers. Financial institutions, which also take more risks when stability reigns, devise ways of getting round regulations and norms once seen as prudent. Eventually the entire economy is a house of cards, built on excessively easy credit and speculation

At some point, the markets hit a peak, a crisis occurs — the Minsky moment —, lenders pull back, panic sets in, and there is a stampede out of the markets. Bankruptcies follow

The Ponzi borrowers are the first forced sellers. Next up are the speculative buyers


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