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Minsky Moment

Minsky Moment refers to a sudden collapse of asset values as part of the credit cycle of expansion and contraction of access to credit over time. This moment starts in the period of stability that encourages risk appetite. High risk appetite leads to instability.

The term was coined by Paul McCulley of PIMCO in 1998 to describe the 1998 Russian financial crisis and was named after economist Dr. Hyman Minsky. Minsky first warned that during the uptrend of economic cycle/ credit cycle, pillars of economy like bankers, traders, and other financiers behave like arsonists; leading to the collapse of the system.

Causes of Minsky Moment

  1. It occurs at the tail end of long period of prosperity in an economy
  2. In an environment of spiraling rise in investment value
  3. Spiraling value leads to increasing speculation
  4. This speculation is supported by more and more borrowed money and debt.
  5. This spiraling debt incurred in financing speculative investments leads to cash flow problems for investors.
  6. The cash generated by their borrowed assets is no longer sufficient to pay off the debt they took on to acquire them. This leads to accumulative losses.
  7. Losses on such speculative assets prompt lenders to call in their loans.
  8. This is likely to lead to a collapse of asset values.
  9. Meanwhile, the over-indebted investors are forced to sell even their less-speculative positions to make good on their loans. However, at this point no counterparty can be found to bid at the high asking prices previously quoted.
  10. This starts a major sell-off, leading to a sudden and precipitous collapse in market-clearing asset prices, a sharp drop in market liquidity, and a severe demand for cash.
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