Hyman Minsky, an American economist who passed away in 1996, is most famous for the idea that “stability is unstable”. His hypothesis is that periods of economic stability encourage investors into taking on more risk because volatility is low. This leads them to borrow excessively and to overpay for assets. Minsky suggested three main types of borrower, increasingly risky in nature:

• Hedged borrowers, who can meet all debt payments - interest and principal repayment - from their cash flows.
• Speculative borrowers, who can meet their interest payments, but can only repay principal when the asset is sold.
• Ponzi borrowers (you remember Chuck), who can’t pay the interest, let alone the original debt, and rely entirely on rising asset prices to allow them continually to refinance their debt.

The longer a period of economic stability lasts, his argument goes, the more society moves towards being full of Ponzi borrowers. Financial institutions, which also take more risks when stability reigns, devise ways of getting round regulations and norms once seen as prudent. Eventually the entire economy is a house of cards, built on excessively easy credit and speculation. At some point, the markets hit a peak, a crisis occurs - the “Minsky moment” - , lenders pull back, panic sets in, and there’s a stampede out of the markets. Bankruptcies follow. Well we haven’t had the “Minsky moment” yet, at least in the equity markets. But Mr Minsky’s analysis is looking pretty good so far, one can certainly recognise the borrowers.

However, the ABX-HE indices look like they are having one.This charming looking chart isn’t just any old BBB- stuff. This chart is the highest-rated AAA credits, supposedly bulletproof. I won’t post the low-rated charts, this is a family-friendly blog and I wouldn’t want to expose small children to that much gore. Click on the chart to see them if you are of a morbid disposition.

These ABX-HE indices track the cost of credit insurance for second mortgages, which have mostly been used as the 20 part of 80/20 loans. First mortgages over 80% financing still require mortgage insurance (PMI) to get a decent rate. So rather than pay for that, lenders have been using an 80% first and a 20% second to provide 100% financing without the additional cost of PMI, just a higher rate on the second. Of course, the downside of this is that when there’s a loss, the second mortgage will bear the brunt. If prices drop 20%, as they have in many bubble areas, then the second mortgage is a total loss. The low-grade tranches of ABX-HE are now pricing in 50% aggregate losses. This means that the cost of these mortgages will be going through the roof, further pressuring the housing market.

“Minsky moment” seems kind of cool and academic, so various gurus are providing the kiddie version. Richard Bernstein, the chief strategist (an industry term for carnival barker) at Merrill Lynch, calls it “Righty-Tighty Time”. Per Bloomberg, Mr Bernstein says: “The incremental risk aversion now evident in the financial markets seems to us to be a sign that the financial liquidity spigot is starting to tighten. The childhood alliteration to remember how to turn a spigot is `righty-tighty, lefty-loosey.’ It’s now righty-tighty time for the financial markets.” From the same piece, Gary Jenkins of Synapse Investment Management, referring to the children’s game, calls it “a KerPlunk moment.” “If all the marbles fall, you lose it all!” went the pitch for KerPlunk. I can only imagine what these folks think of the IQ of their audience when they both choose analogies from the knowledge base of 6-year-olds. Not suggesting that they’re wrong to do so, however.