Its ‘Minsky Moment’ time again as investors start to worry about return of capital

Banking has always essentially been a confidence trick. Banks fund themselves from short-term deposits. And then they lend out this money on a longer-term basis – maybe months, or even years.

But they don’t just lend the money on deposit. As the central bankers’ bank, the BIS, noted in 2014:

“Banking is all about leverage. Put simply, banks are highly leveraged institutions that are in the business of facilitating leverage for others.”

Thus every banking cycle mostly follows the same pattern:

  • As the business climate starts to improve, they increase their lending
  • Initially, they lend to customers who survived the last downturn, so the risks are low
  • But then a new set of managers arrive, who think their predecessors were much too cautious
  • Sure of their own ability, they increase leverage and lending – and book fat profits for a while
  • But then the next downturn comes along, and lots of their new customers go bust

After that, it’s a case of “rinse and return” as the Financial Times chart confirms. As they note, during the long bull market from 2002 – 2021:

“Among the 24 major industry groups, banks came in dead last, with annualised total returns over that period of less than 6%, less than half the return on the wider market”.

And, of course, in the middle of this period – in 2008 – they almost crashed the global financial system.


In other words, it seems that bankers never learn. Or at least, they rarely stay in post long enough to learn from their mistakes.

As long-standing readers will remember, we spent much of the 2005-8 period warning that the USA was heading for a major financial crisis. And one of our key guides to the period was Hyman Minsky.

As we noted here then in September 2008:

“His insight was that a long period of stability, such as that experienced over the past decade, eventually leads to major instability.

“This is because investors forget that higher reward equals higher risk. Instead, they believe that a new paradigm has developed, where high leverage and ‘balance sheet efficiency’ should be the norm. They therefore take on high levels of debt, in order to finance ever more speculative investments.

“Eventually, however, a ‘Minsky moment’ occurs. Earnings from the new investments prove too low to pay the interest due on the debt. Confidence in the ‘new paradigm’ disappears and, with it, market liquidity. Investors find themselves unable to sell the under-performing asset, and suddenly realise they have over-paid. In turn, this prompts a rush for the exits. Prices then begin to drop quite sharply, as ‘distress sales’ take place.”

It was obvious back in the summer that things were going badly wrong. And as we discussed in detail in June:

“Markets will see plenty of rallies, but history suggests the real bottom will be at least 2 years away”.

9 months later, it seems that consensus thinking now agrees with us.  Even the Wall Street Journal warned earlier this month:

“You can’t run the most reckless monetary and fiscal experiment in history without the bill eventually coming due. The first invoice arrived as inflation. The second has come as a financial panic, with economic damage that may not end with Silicon Valley Bank.”

On Friday night, I was interviewed by Maggie Lake of Real Vision.

We discussed where the real risks might be hiding in financial markets?

In the USA? In Europe? Or are they in Asia?

Please click here to view it.