Are we at the Minsky moment?
The Financial Instability is a hypothesis developed by Hyman MINSK. The later argued that the financial system is rule by a succession of a Stability periods and Instability periods and so that crisis (here financial crisis) are endemic to a capitalism paradigm. Financial Stability breeds to success and excess of optimism and so generate bubbles and a crisis when it burst.
The underlying mechanism explaining the transitions from a Stable system to an Instable is as follow:
Considering a traditional banking system in which bank lending is secured against assets and so hedged against default (as example Mortgages for Real Estate loans). In economic growth period both lenders and borrowers are optimistic and so they are willing to take more risk anticipating prices increases (prices of financials assets, Houses etc …). Consequently, Banking sector are also willing to lend more while insist to reduce deposits (lending becomes more leveraged). In this case, the biggest lender agents/banks tend to contribute this optimism as their lending activities (increasing) support prices increases. The excess of optimism appears at this stage as both lenders and borrower’s activities depend to a constant increase of prices. Later, Robert Schiller qualified this phenomenon as ‘’Irrational Excuberance’’.
However, both banks and financial institutions are involved in this excess of optimism and so tends to support the prices hike even if more and more speculative behaviors and Ponzi’s scheme investment are generated!
However, when all agents realized that them cannot hedged their loans with assets the bubble burst as they are both enough cash to refunds and should massively sell assets to face liquidity issue.
In this process, Minsky Moment refers to the point where the system became instable or when overindebted agents start to massively sell off their assets. In this case, a liquidity crisis appears as financial institution could not satisfy their cash needs.
Initially, H.MINSKY pledged for a Regulation of financial markets to identify and cuts all speculative behaviors. But in some case, regulatory authorities could contribute to support the ‘’irrational excuberance’’ (through Rating credit errors, Low interest policy etc ….).
H.MINSKY observed that before some crisis, the Houses Prices increased continuously favoring Mortgage loans … The 2007-2008 credit crisis are one of example illustrating the Minsky Financial Instability theory.
According to H.MINSKY, this aspects is related to Capitalism thought in which Profit seeking is the basis. Economic agents are not interested in “moderated profits” as the context push them to take more risk to generate ‘’excess profit” failing to measuring underlying risk…