The Edmond Sun


December 13, 2013

THE ASTUTE INVESTOR: Looking for the Minsky moment

EDMOND — As we approach the end of the year, I want to step back and look at the big picture. By that I mean the economy and the markets. The stock market has been hitting new all-time highs and it’s certainly a fair question to ask how far it can go.

Great news! New Federal Reserve chair-designate Janet Yellen says there are no bubbles forming anywhere. Not in real estate, not in the stock market, not anywhere. Well that’s a relief. The markets took it that way, despite the opinions of some, including David Stockman, former budget director under Ronald Reagan, who argues that “we have bubbles everywhere,” in stocks, junk bonds and a housing market “riddled with a new wave of speculators.”

But the relief is understandable because Fed chairmen know what they’re talking about when it comes to bubbles, recessions and bear markets. Well, there was this little hiccup in 1999 when then-Fed Chairman Alan Greenspan said, “Nah” to the question of whether we were in a stock market bubble. And a housing bubble in 2004? Nah. And then there was that little matter with Ben Bernanke about a sub-prime mortgage bubble? Nope. “It’s contained.” Oh well. Maybe this time is different.

I have always been a student of economic history. Most people who have known me for awhile know I consider myself more of a macro economist and one who uses demographics to understand the big picture and long-term trends. In doing so, I have generally been right about those trends. While demographics and macro trends are valuable, they don’t tell us much about the short-term.  That is a completely different challenge.

One of my favorite economists is a guy named Hyman Minsky, an American economist who died in 1996. His research attempted to provide an understanding and explanation of the characteristics of financial crises. Isn’t that a great name for an economist? It just sounds like one. OK, I know it’s kind of weird to have a favorite economist.

One of the things Minsky was known for was his studies on debt. Not all debt is bad. There is productive debt, such as debt that produces something or creates something of value. Infrastructure improvement, public works, roads, bridges, etc., come to mind. In the private sector it might be plant and equipment and things that help produce something. Then there is unproductive debt, such as debt to generate consumer spending or temporary demand. In the end, the money is spent and there is not much to show for it. Finally, there is counterproductive debt, such as debt to pay other debt.

The problem we have today, both in the public and private sector, is we have too much unproductive and counterproductive debt instead of the productive kind.

Anyway, Minsky also was known for his theory that stability breeds instability.  In other words, the longer things are good and going well, the more comfortable and complacent people become. The more comfortable and the more they believe things are good, the more they are likely to spend and invest and eventually even take risk. Things get better and better and the risks get higher until eventually it is no longer sustainable. 2007 was a good example. The collapse of housing in just four states was the trigger that led to a global financial crisis.

This is the classic definition of the business cycle and why things go from highs to lows and back over a period of time. Think of it like slowly pouring sand onto a pile. It gets higher and higher until finally one grain of sand triggers instability and the pile collapses. In economic terms, that has become known as the Minsky moment.

I tell you all this because I think we are building a number of potential Minsky moments and risks. I don’t know when the market will top. No one knows that. However, I do know that no market goes up forever. You can’t make decisions based upon the news, because the news is always good at the top, just as the news is always terrible at the bottom. They don’t ring a bell when the market tops.

While the economy seems to be improving and the market is hitting new highs, there are a number of underlying issues deteriorating. Many are minor, but collectively they have the potential for damage. At some point, probably sometime in 2014, we are going to find that Minsky moment. Which one will it be? Something to think about. Thanks for reading.

NICK MASSEY is a financial adviser and president of Householder Group Financial Advisors in Edmond. Massey can be reached at Securities offered through LPL Financial, member FINRA/SIPC.


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