Friday, 30 January 2009

crystal balls

A Minsky moment is the point in a credit or business cycle when investors have cash flow problems due to spiralling debt they have incurred in order to finance speculative investments. At this point, a major selloff begins due to the fact that no buyer can be found to bid at the high asking prices previously quoted, leading to a sudden and precipitous collapse in asset prices and a sharp drop in market liquidity.

So says Wikipedia. For me a Minsky Moment is an epiphany, a mass realisation that such and such a market is a speculative bubble about to burst. Herd behaviour being what it is the bubble does burst as investors panic sell en masse. If only we could spot them.

Well I think we can sort of. The old joke was when your dentist started giving you stock tips you knew it was time to sell. This was updated after the dotcom bubble – when people started talking about a “New paradigm” you knew it was the time to get out quick.

Except, the cynicism attached to the "New paradigm" comment was recognised as having more than a grain of truth to it, hence the boosters of the private equity mega-deals seen before the credit crunch avoided it in favour of dull arguments about the alignment of interests between senior managers and owners. Commercial property never quite attracted the brains private equity did so on occasion its boosters did refer to paradigm shifts if not new paradigms and then only in passing.

So if clich├ęs aren’t much of a guide what is? Unfortunately, it’s commonsense. You see speculative bubbles typically generate behaviour that’s so stupid, so over the top and so too good to be true even a modicum of common sense should let you step back and decide “Nah, I’m getting out of here”. Examples of this include the Japanese frenzy for investing in golf clubs (prior to the lost decade) that prompted the creation of a golf club investment index. During the dotcom bubble it was enterprise values that implied every customer of say petfood.com generated an EBITDA of $200,000 a head. Closer to home it would be the Investment Property Databank organising a conference on alternative property assets that included the joys of investing in yachting marinas and tree plantations. Or it could be the root of the current crisis and selling mortgages to NINJAs (no income, no job or asset borrowers) who could barely afford the upfront teaser rates let alone what the mortgages cost when they reset to realistic levels.

The same three factors apply to each of these examples of fringe investments moving into the mainstream. One, you’re scraping the barrel to find something to invest in because the mainstream market just doesn’t work regardless of whatever financial innovation you throw at it. Two, you’re scraping the barrel because of bureaucratic reasons which in banking means you’ve sales/profit targets to meet to get your bonus. And three, if you do have second thoughts and question a superior about it ultimately, other than blind faith either in them or someone else (a ratings agency perhaps), the only justification they can give that makes any sense is “I am superior to you therefore you will do what I tell you”.

So there you go, that’s how to anticipate a Minsky Moment. Of course you won’t get it precisely right and might even pull out one, two or even three years early. But, given the magnitude of the collapse in bank equity values and losses we’ve seen and the extent to which these have cancelled out years of profits so feckin what?

P.S. This leaves the issue of leadership and who sets the stupid targets that drive businesses over the cliff in the first place.

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