What is a Minsky Moment?
A Minsky moment refers to a sharp decline in prevailing market sentiment and economic productivity after a long period of widespread optimism.
How Does a Minsky Moment Work?
Times of robust economic growth, like that experienced by the U.S. from 1993-2001, can be characterized by low unemployment, high credit availability, increasing asset prices and a general expectation that good times will continue into the foreseeable future.
Unfortunately, these long periods of relative stability tend to encourage market speculation -- investors start investing in assets because they believe prices will never go down for more than a short period of time before bouncing back. The speculation is increasingly fueled by borrowed money, and once a sustained period of declining prices starts impacting investors’ ability to repay their debts, a Minsky moment occurs.
A Minsky moment occurs when what former Federal Reserve Chairman Alan Greenspan termed 'irrational exuberance' becomes undermined by the economy's inability to maintain such exhaustive levels of growth. As economic data reflects slowing growth, consumer demand and spending also decline. As a result, capital and real estate market values decline, and the credit markets experience tremendous turmoil as borrowers are faced with debt obligations that they cannot meet.
Why Does a Minsky Moment Matter?
The U.S. economy experienced a Minsky moment with the onset of the credit crisis that began in 2008. As banks approved loans and mortgages that borrowers could not repay, the banking system experienced crippling levels of insolvency that had widespread consequences for economic growth and employment.