24 Hyman Minsky and the Paradox of Stability: Why Boom Times Can Lead to Crashes

Until the 2009 subprime mortgage market crisis, the name Hyman Minsky was largely unknown outside of academic circles. He was an economist whose theories had been overlooked for decades – until the global financial meltdown made people realise he had predicted such crises long before they happened. But what exactly happened in 2009? What kind of financial disaster did we experience that brought Minsky’s theories into the spotlight?

Before 2009, the global economy was booming. The financial sector was in a period of rapid expansion, and key players in the industry saw this as a golden opportunity. Investment banks, mortgage lenders, and financial institutions wanted to capitalise on the booming market as much as possible. Their thinking was simple: the more mortgages they approved, the more money they could make from interest payments and the resale of mortgage-backed securities (MBS) in secondary markets.

Traditionally, the mortgage market worked on relatively conservative principles. If someone wanted to buy a house, lenders would assess their financial standing. They would evaluate factors like:

• How much down payment the borrower could afford
• Whether the borrower had a permanent job
• Their credit history
• Their overall financial stability

Only those who fell within an acceptable risk threshold were granted mortgages. Those with lower credit ratings were categorised into different tiers – AA, A, BBB+, and so on. These mortgage-backed securities were then packaged and sold in the secondary market, where investors could buy them based on the level of risk they were willing to take.

However, the financial sector’s key players came up with a seemingly brilliant idea: why not expand the risk threshold? If they could lend to even riskier borrowers, they could generate even more business. After all, they reasoned, even if these high-risk borrowers defaulted on their loans, the banks could always seize their homes and sell them. The housing market was booming, so selling repossessed houses should have been an easy way to recover losses.

This logic led to the explosion of subprime mortgages – home loans given to borrowers with low creditworthiness. Mortgage lenders aggressively pushed these risky loans, often without verifying the borrowers’ ability to repay them. Some mortgage brokers even falsified income data to approve more loans, all in the pursuit of higher commissions. Between 2000 and 2007, subprime mortgage issuance skyrocketed, reaching over $1.3 trillion in outstanding loans by the peak of the housing bubble.

Then came the moment of reckoning. As expected, many of these subprime borrowers couldn’t keep up with their mortgage payments. Banks and mortgage providers started foreclosing on homes, seizing properties, and putting them up for sale. This is where the financial sector’s supposedly “safe” plan fell apart.

As a massive number of foreclosed homes flooded the market, housing prices plummeted. The average U.S. home price, which had reached its peak in 2006, dropped by nearly 30% by 2009. This had a cascading effect: suddenly, even those who were financially stable before the crisis found themselves in a difficult position.

Imagine you bought a house for £300,000, and you had been diligently paying your mortgage every month. But now, due to the price crash, your home’s market value had dropped to £250,000 or even lower. You were paying off a mortgage that was far higher than what your house was actually worth. Many homeowners began to ask themselves: why should I keep paying such a high mortgage on a house that has lost so much value?

In the United States, personal bankruptcy laws allowed homeowners to walk away from their mortgage debts relatively easily. Filing for bankruptcy would impact their credit score for about seven years, but for many, this seemed like a better option than continuing to pay for an overvalued property. As a result, even borrowers who had initially been considered “safe” started defaulting on their loans en masse. This was the tipping point – a crisis that was once contained within the subprime market now spread to the broader economy.

The financial sector had been heavily invested in these mortgage-backed securities, and banks around the world had exposure to them. When the value of these assets collapsed, so did confidence in the financial system. The crisis rippled through the economy, causing major financial institutions to fail. Lehman Brothers, a 158-year-old investment bank, collapsed in September 2008, triggering the worst financial panic since the Great Depression. Stock markets plunged; the Dow Jones Industrial Average lost 50% of its value between 2007 and 2009. Global GDP shrank by more than $2 trillion, and unemployment surged across the world, reaching 10% in the U.S. and similar levels in other economies.

Enter Hyman Minsky: The Prophet of Financial Instability

Just as the financial world was scrambling to make sense of what had happened, some economists pointed out that Hyman Minsky had predicted this kind of crisis decades ago. His theories, which had largely been ignored before, were suddenly being taken seriously. The term “Minsky Moment” became widely used to describe what had just happened.

Minsky’s core idea was that stability breeds instability. He argued that during economic booms, financial institutions and investors take on increasingly risky behaviour, believing that the good times will last forever. They gradually shift from safe, conservative investments to speculative and even Ponzi-like financial structures. Eventually, the system reaches a tipping point where excessive risk-taking leads to a sudden and catastrophic collapse – exactly what happened in the 2009 crisis.

Minsky identified three stages of financial risk:

Hedge Finance (The Safe Zone)

In this phase, borrowers play it safe. They take out loans but can comfortably pay back both the principal and interest without borrowing more.

Speculative Finance (The Risky Zone)

As confidence grows, borrowers start taking more risks. They can afford to pay interest on their loans, but they don’t have enough cash to pay back the principal immediately. Instead, they refinance their debt – kicking the can down the road.

Ponzi Finance (The Danger Zone)

In the final stage, debt spirals out of control. Borrowers can’t even pay interest on their loans without taking on new debt. They rely on asset prices continuing to rise to stay afloat. When the market turns, these highly leveraged borrowers collapse, taking the economy down with them.

This cycle explains why financial crises aren’t random, they are baked into the system during good times. A Minsky Moment is the tipping point when financial stability turns into chaos. Investors, businesses, and banks suddenly realize that debts can’t be repaid. Panic sets in, asset prices crash, and a credit crunch follows.

Some classic Minsky Moments in history:

• The Great Depression (1929): The roaring ’20s were fuelled by excessive stock market speculation and easy credit. When the bubble burst, the economy crashed.
• The Dot-Com Bubble (2000): In the late ’90s, tech stocks skyrocketed, driven by speculation rather than real profitability. When reality hit, the market collapsed.
• The 2008 Financial Crisis: Risky mortgage lending and financial speculation created a housing market bubble that led to the worst financial crisis in decades.

Minsky Moments remind us that financial markets are not naturally stable – they are vulnerable to collapse when risk-taking spirals out of control.

Even though Minsky passed away in 1996, his insights remain incredibly relevant. Governments and central banks still struggle with how to manage financial booms and busts.

If economies naturally move toward instability, can policymakers prevent Minsky Moments?

Central banks like the Federal Reserve, the European Central Bank, and the Bank of England attempt to slow down excessive borrowing by:

• Raising interest rates when they see too much risky lending.
• Regulating banks to prevent reckless financial speculation.
• Acting as lenders of last resort to stop financial collapses from spreading.

However, Minsky’s theory raises an uncomfortable question: do central banks really control the economy as much as we think? If commercial banks create most of the money through lending, and lending decisions are driven by financial market confidence, then central banks may have less control than traditionally assumed. Instead of steering the economy like a captain at the helm, they might be more like lifeguards – watching from the sidelines and jumping in when things go wrong.

Minsky’s greatest lesson is that financial stability is an illusion. The longer an economy avoids a crisis, the more confident investors and borrowers become – until, eventually, the system collapses under its own weight. Understanding this pattern can help us recognise financial bubbles before they burst. More importantly, it can guide policymakers in designing safeguards to prevent excessive risk-taking. Minsky Moments will continue to happen, but by learning from the past, we can try to make financial crashes less severe – and maybe even avoid the worst of them.