Unknown to most people, economist Hyman Minsky spent the latter part of his life feuding with dyed-in-the-wool efficient market theorists as he argued that markets were open to periods of speculation that could end in crises. An interesting article appeared in Saturday's Wall Street Journal that explains how many traders and analysts are beginning to think Minsky wasn't so crazy after all.
In fact, Wall Street has even began to use the term "Minsky moment" to describe times when over-leveraged investors are forced to sell their good investments to cover losses on borrowed money.
It seems that the market's action in the last few weeks could be considered a near Minsky moment as quant hedge funds were forced to cover positions, several hedge funds blew up due to leveraged subprime exposure, and so on. In fact, a fund manager interviewed in the Wall Street Journal piece believes we are "bordering a Minsky meltdown."
How do these Minsky moments come to be, you may ask. The primary cause is optimism leading up to the "moment." It's this optimism that forces investors to chase higher returns, borrow more money, and become even more aggressive with their trading. Once a negative catalyst hits and pessimism sinks in, a small market downturn is compounded immensely by the leverage issues that come forth.
It's interesting that Minsky's theories, which are proving ever-so-true in recent times, were considered to be ridiculous and even bogus just fifteen years ago. In these times, proponents of the efficient market theory ruled the academic-economic world. While the efficient market theory certainly has its merits (most importantly, most people can't/don't beat the market), the argument that markets are fully efficient has been completely disproved in most academics' eyes. Great long-term track records aren't nowhere to be found (although they're rare) and events like Minsky moments have become painful realities as leverage, derivatives, and other risky tools are all favorites for America's most influential fund managers.
Nuclear power is on the comeback trail
Apple backs AT&T in continuing spat with Verizon
Closing Bell: The recession is still over, still... do you feel it?
