back to news & insights


Mar 09, 2015

Reader Feedback: Where was the stability?

Bill Miller

A question about Part I: Time Travel in the Minsky Moment was submitted during our 4Q2014 investor call that I thought would be useful to share broadly with our readers.  The question states:


"Bill wrote about the Minsky Moment which states that, 'Financial stability creates instability', thus the financial crisis.  But, prior to 2007 there was Long-Term Capital Management, the downturn in the stock market from 2001 to 2003, the list could go on.  So, where was the stability?"


It's a good question, but I think the question misunderstands what Minsky's point was.  Minsky was talking about macroeconomic volatility.  As that declines, stability goes up and we get longer distances between recessions.  Those declines in macroeconomic volatility lead people to take more risk, which then, in turns leads to instability.

The examples given by the reader were precisely that case.  Long-Term Capital Management - that's a perfect example of a Minsky Moment.  They had a long period of data indicating that they could really lever up, take more risk and earn returns that way.  At some point, that flipped over and LTCM got wiped out.

The same thing happened, though a different kind of case, with the internet bubble.  There the combination of innovation, an environment of rapidly rising corporate profits and stock prices, coupled with the federal budget moving into surplus led to an "irrational exuberance" that sowed the seeds of its own demise.

What Minsky was talking about in the context that culminated in the financial crisis of 2008 was we had a 25-year period where economic volatility consistently declined, a period Fed chairs Bernanke and Greenspan referred to as the Great Moderation.  This led, again, to increased risk taking through excessive leverage, especially in the housing sector.  The long stable progression of house price increases was the cause of the increased risk taking that finally culminated in the collapse of housing prices for the first time since the Great Depression.

Stability created instability, exactly as Minsky hypothesized.

Any views expressed are subject to change at any time, and LMM disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results.

©2015 LMM LLC. LMM LLC is owned by Bill Miller and Legg Mason, Inc.