[Song Seungseop's Financial Light] The Point Where Finance Collapses: The 'Minsky Moment'

Since the COVID-19 pandemic has entered its final phase, warnings about the ‘Minsky Moment’ have been steadily raised. In fact, the Minsky Moment is a common economic term that is always mentioned whenever a financial crisis occurs. So, why is the Minsky Moment drawing attention?

The Minsky Moment refers to the ‘Financial Instability Hypothesis’ proposed by American economist Hyman Minsky. The core of the hypothesis is that after the economy improves by increasing debt significantly, borrowers whose ability to repay debts deteriorates eventually sell even sound assets, leading to the collapse of the financial system. American economist Paul McCulley coined the term ‘moment’ when he cited Minsky’s hypothesis to explain the Russian financial crisis.

Simply put, the Minsky Moment is a hypothesis that shows ‘how a boom created by excessive borrowing collapses.’ For example, suppose in country A, it becomes easy to borrow money, and the number of people buying stocks and real estate increases sharply. As investment demand rises, the prices in the stock and real estate markets rapidly increase. Seeing the soaring prices, even those who were not interested in investing start buying stocks and real estate, further overheating the market.

However, no boom lasts forever. At some point, people become fearful that prices will no longer rise. This point, where growth falters, is the Minsky Moment. Now, those who invested with borrowed money begin to lower prices and sell their investment assets one by one. The problem arises when the number of sellers increases. Who would want to buy stocks and real estate when prices show signs of crashing? Frightened investors start offering assets at bargain prices. Prices then plunge even faster.

Minsky Moment Structure

Financial institutions that lent money at low interest rates during the boom suddenly change their stance. As the market worsens, doubts grow about whether they can recover the loans they extended. Banks focus on recovering the money they lent. They dispose of the collateral entrusted by investors. Now that even investors’ collateral is being sold, the market begins to collapse uncontrollably. Even those without debt feel the fear of market collapse. Seeing asset prices fall, people start disposing of even sound assets as quickly as possible. Despite their best efforts, banks fail to recover the money and go bankrupt, triggering a financial crisis.

Why did Minsky think such phenomena occur? He believed the cause lies within the capitalist system itself, not due to any special external factors. Can moments of steady national growth continue if economic agents strictly manage risks and households save diligently? Minsky argued that as confidence in growth strengthens, people’s speculative tendencies increase. Since the economy will inevitably grow, more people engage in risky investments like ‘debt investing’ to make big profits.

The Minsky Moment was not a theory that initially attracted much attention. Rather, it began to be widely used after Minsky’s death in 1996. The turning point was the 2008 U.S. subprime mortgage crisis. At that time, optimistic expectations about the housing market led to a sharp increase in mortgage lending, and when those expectations collapsed, the financial market also collapsed. Looking back at various financial crises, it was found that the phenomena described in Minsky’s hypothesis actually occurred.

Recently, the Minsky Moment has been mentioned because global financial market debt has surged due to COVID-19. According to major foreign media, Marco Kolanovic, JP Morgan Chase strategist, sent a message to his investors earlier this year saying, “The possibility of a market and geopolitical Minsky Moment is increasing,” and “Even if central banks successfully control it, credit conditions are likely to deteriorate much faster than now.” In May, Ludovic Subran, chief economist at Allianz, said, “We have all the elements of a Minsky Moment, and liquidity crises are appearing everywhere,” adding, “The link between commercial real estate and U.S. regional banks is worrisome.”

Editor's NoteFinance is difficult. Confusing terms and complex backstories are intertwined. Sometimes, you need to learn dozens of concepts just to understand one word. Yet finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Therefore, Asia Economy selects one financial issue each week and explains it in very simple terms. Even those who know nothing about finance can immediately understand these ‘light’ stories that illuminate the ‘light’ of finance.

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