When the acute phase of the Great Financial Crisis hit in the fall of 2008, many Economists were quick to call it a “Minsky moment”.  Based on the research into financial crises by Economist Hyman Minsky,

A Minsky moment is a sudden major collapse of asset values, which is part of the credit cycle or business cycle.

If the definition of a Minsky moment stopped there, I would have no trouble with using it to describe the acute phase of the Great Financial Crisis.  Unfortunately, the definition goes on to describe the causes of these moments.

Such moments occur because long periods of prosperity and increasing value of investments lead to increasing speculation using borrowed money.

While all of these “causes” are correlated with the acute phase of a financial crisis (they are actually characteristics of the financial market at the time the acute phase of a financial crisis occurs), none of them actually cause the Minsky moment to occur.

While Professor Minsky recognized financial markets are more unstable following long periods of prosperity, increasing investment values and higher leverage, he doesn’t have a trigger for why a financial crisis occurs.

I think Professor Minsky would have liked the Information Matrix.  It fills in the gaps in his work.

As regular readers know, the Information Matrix identifies the underlying cause of financial crises.

The Information Matrix introduces the idea transactions occur where neither the buyer or seller has access to the information they need to know what they own or are buying.  These transactions occur in the Blind Betting quadrant.

Information Matrix

	Does Seller Know What They Are Selling?
Does Buyer Know What They are Buying?		Yes	No
	Yes	Perfect Information	Antique Dealer Problem
	No	Lemon Problem	Blind Betting

Recognition of the Blind Betting quadrant’s existence has profound ramifications for Economics.  As for the first time, it lets Economists explain where financial crises come from.

As Professor Minsky accurately notes, as the value of investments increases, so too does the willingness of investors to speculate.  Wall Street takes advantage of the increased willingness to speculate to increase the sales of the high margin, opaque securities that occupy the Blind Betting quadrant of the Information Matrix.

How does Wall Street increase the sale of these opaque securities?  Wall Street realizes people like a good story.  Each of these opaque securities comes with a good story.  Wall Street puts its time and effort into finding people (individuals, asset managers, etc) who will speculate on these story-based securities without having the information necessary to verify all elements of the story are true.

For a while, these speculative investments generate a positive return as it appears the story will have a happy ending.  But then, the story is called into doubt.

When this happens, we witness a Minsky moment.  The value of the opaque securities heads to zero.  This occurs because the absence of facts eliminates any logical stopping point in the price decline.  Buyers of opaque securities know this.  Hence, as soon as the valuation story is called into doubt, they “run” to get their money back.  This “run” tends to be contagious.  It calls into doubt the value of all the other opaque securities (including banks) in the financial system.  If the opaque sectors of the financial system are large enough, the result is a financial crisis.

If you look at the acute phase of the Great Financial Crisis, you will see this is exactly what happened.  Wall Street sold opaque subprime mortgage-backed securities and related derivatives with a good story about how house prices have never declined nationally.  Then, the value of the opaque securities was called into doubt when Too Big to Fail bank BNP Paribas said it couldn’t value them.  The doubt about the value of the subprime securities spread doubt along the opacity fault line in the financial system.  Investors asked who was holding the losses on the subprime securities.  When they discovered the opaque banks were, the acute phase of the Great Financial Crisis was on.

Financial crises originate in the Blind Betting quadrant.  They occur when the valuation story told about the speculative opaque securities in this quadrant is called into doubt.