The ‘Minsky moment’ unfolds

Currencies, Economic growth, Financial Events, Leverage

Minsky.jpg

Pimco, the world’s largest bond fund, have repeated their belief that we are facing a ‘Minsky moment’, named after Hyman Minsky (pictured). His insight was that a long period of stability, such as that experienced over the past decade, eventually leads to major instability.

This is because investors forget that higher reward equals higher risk. Instead, they believe that a new paradigm has developed, where high leverage and ‘balance sheet efficiency’ should be the norm. They therefore take on high levels of debt, in order to finance ever more speculative investments.

Eventually, however, a ‘Minsky moment’ occurs. Earnings from the new investments prove too low to pay the interest due on the debt. Confidence in the ‘new paradigm’ disappears and, with it, market liquidity. Investors find themselves unable to sell the under-performing asset, and suddenly realise they have over-paid. In turn, this prompts a rush for the exits. Prices then begin to drop quite sharply, as ‘distress sales’ take place.

Pimco argue that housing markets were the first to experience the ‘Minsky moment’. Now it is occurring amongst those who financed the housing boom. Pimco’s forecast is that this process will continue. They believe we are now ‘moving through this progression backward, with asset prices falling, risk premiums moving higher, leverage getting scaled back and economic growth getting squeezed’.

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