What’s a Minsky Moment and Why Are There Worries About One?

(Bloomberg) -- The mere mention of a “Minsky moment” — a sudden crash of markets and economies that are hooked on debt — is enough to send shudders through policy makers. The theory stems from the work of Hyman Minsky, a US economist who specialized in how excessive borrowing fuels financial instability. From time to time, booms in financial markets or sky-high debt levels around the world lead to renewed interest in Minsky’s theory or warnings from the International Monetary Fund, among others. US Treasury Secretary Janet Yellen once described his work as “required reading.”

1. What makes a Minsky moment?

The term refers to the end stage of a prolonged period of economic prosperity that has encouraged investors to take on excessive risk, to the point where lending exceeds what borrowers can pay off. At that point, Minsky wrote, there’s an increase in “speculative and Ponzi finance.” When a destabilizing event as simple as an increase in interest rates occurs, investors can be forced to sell assets to raise money to repay loans. That in turn sends markets into a spiral amid a demand for cash. There have been attempts to distinguish between a Minsky moment and a Minsky process that leads up to it.

2. Have there been Minsky moments?

Yes. In 1998, following the bursting of asset bubbles in Asia, Russia defaulted on its domestic debt and devalued the ruble. (It was during that crisis that Paul McCulley, then an economist at Pacific Investment Management Co., coined the term “Minsky moment.”) The global financial crisis of 2007-2008 is considered another Minsky moment, since it was caused by the implosion of the US subprime mortgage market.

3. Who was Minsky?

Minsky studied at the University of Chicago and at Harvard University, where he was a teaching assistant to Alvin Hansen, who coined the term secular stagnation. From 1957 to 1965, Minsky was an associate professor of economics at the University of California, Berkeley, where he developed his major theories. He died in 1996, before his ideas gained wide prominence.