Bloomberg Magazine asked CFE Co-Director Bob Barbera if the current low level of the VIX and high hedge fund leverage meant that the economy was on the brink of another Minsky moment. Here is his reply.
The late economist Hyman Minsky brilliantly documented that attitudes toward risk taking evolve in a predictable pattern over the course of business cycles. In the aftermath of a recession, bankers, borrowers, business leaders and heads of households all decide that SAFETY is the paramount. As economic recovery takes hold and memories of retrenchment recede, economic decision makers, collectively, begin, slowly but surely, to move toward strategies that promise more return but are inherently riskier.
Where do we stand in early 2013? The 2008-2009 financial crisis and Great Recession delivered asset market mayhem not seen since the Great Depression. Quite predictably, this produced a collective leap toward SAFETY of unprecedented proportions in the Post-Depression period. Household debt as a share of income fell for four years. Bankers radically tightened lending standards, resulting in loan growth well short of deposit gains and an explosion of excess reserves. Corporations accumulated an unprecedented cash hoard. This deep seated angst no doubt played a significant role in the tentative nature of economic recovery. In response to both financial system angst and sub-par recovery, central banks around the world have embraced super easy monetary policy stances.
Now, however, there are signs of some renewed optimism. Residential real estate in the United States, the centerpiece of the financial market crisis, appears, at long last, to be mounting a genuine recovery. Bankers are relenting, a bit, from deeply restrictive lending practices. Investors, faced with de minimis nominal return prospects, have been forced out the risk curve. Corporate borrowing costs and some risk measures, as a consequence, now look low.
A Minsky moment in the making? Not so fast! The deadly admixture that elicits Minsky like financial system crises is a combination of risky finance and CENTRAL BANK TIGHTENING OF MONEY AND CREDIT.
It is true, at present, that some financial market measures are looking relatively risky. But the economic backdrop, to date, simply haven’t signaled that easy money will soon be reined in. Paradoxically, a spate of much better than expected economic news–six months of 300,000 per month jobs growth?–and the world would have to radically recalculate the timing of Fed tightening. Boom, and the prospects of tighter Fed policy, would invite serious financial market redress.
The delicious Minskyian irony? Angst about a return to recession, which has persisted in this recovery for four years, keeps the Fed on hold and the asset market recovery on track. Unambiguous economic strength, and the recognition that Fed largess is no longer needed on Main Street, is the more serious threat to asset market returns