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John Mauldin's Outside the Box - Minsky’s Financial Instability Hypothesis

March 26, 2014 | About:

Minsky’s Financial Instability Hypothesis

John Mauldin

March 25, 2014

Looking back, I see that I have mentioned the name Hyman Minsky in no fewer than ten Thoughts from the Frontline letters in just the past two years; and his name has popped up in all four letters so far this month, most notably on March 1, when we brought back one of my most popular pieces, “Black Swans and Endogenous Uncertainty” (the “sandpile” letter) and last week, when the letter was titled “China’s Minksy Moment?”

I wasn’t consciously aware of how often I had trotted Minsky out as I sat (somewhat unstably, I have to admit) atop a headstrong horse in the foothills of the Argentine Andes the other day; but my precarious situation did somehow get me thinking of Minsky’s Financial Instability Hypothesis, and it occurred to me that both you and I might learn something by going right back to its source, which turns out to be a rather unprepossessing five-page paper Dr. Minsky published at Bard College in 1992.

Minsky’s work was roundly ignored by the economics profession and policy makers alike … until all hell broke loose in the financial industry and then the global economy in 2008. At the time (in Dec. 2007), I described Minsky’s thesis like this:

[E]conomist Dr. Hyman Minsky points out that stability leads to instability. The more comfortable we get with a given condition or trend, the longer it will persist and then when the trend fails, the more dramatic the correction. The problem with long-term macroeconomic stability is that it tends to produce unstable financial arrangements. If we believe that tomorrow and next year will be the same as last week and last year, we are more willing to add debt or postpone savings in favor of current consumption. Thus, says Minsky, the longer the period of stability, the higher the potential risk for even greater instability when market participants must change their behavior.

The term Minsky moment was coined in 1998 by my good friend Paul McCulley (who, by the way, will once again entertain and enlighten us at the upcoming Strategic Investment Conference, May 13-16). He was characterizing the Russian default and ensuing Long Term Capital Management debacle, but he got to reprise the term (and how!) in ’08. And then everybody jumped on the “Minsky moment” bandwagon.

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