Barron's: Asset Prices Are Climbing as Debt Soars. Will We Be Ready When the Music Stops?

Article by Desmond Lachman in Barron's

The 2008-2009 global economic and financial-market crisis taught the world a painful lesson about Minsky moments. Such a moment occurs when asset prices collapse and interest rates on risky loans soar following a prolonged period of reckless, speculative activity.

Hyman Minsky, the late American credit-cycle expert, taught us that a prolonged period of financial-market stability tends to set up the conditions for pronounced financial-market instability. By this he meant that as economic confidence rises and as asset prices soar, the financial system tends to make increasingly risky loans on the assumption that asset prices will rise forever. When asset prices eventually stop rising and when lenders realize that they might not get repaid, the whole credit-market house of cards collapses.

If ever we have experienced a period of highly risky lending in the context of rapidly rising asset prices, it has to have been that of the past eighteen months. The financial system has lent with abandon even as U.S. equity valuations jumped to nose-bleed levels experienced only once over the past 100 years and as U.S. housing prices adjusted for inflation exceeded their 2006 precrisis peak. Fueling this lending spree was the approximately $5 trillion in Federal Reserve bond purchases in response to the pandemic that induced investors to stretch for yield.

One indication of excessive lending is the more than $1 trillion that has been loaned to highly leveraged U.S. companies and the skyrocketing of global debt to a level well in excess of its precrash 2008 peak. According to the International Institute for Finance, global debt reached almost $300 trillion by the second quarter of 2021. In relation to GDP, this was some 350%, above the 280% before September 2008 Lehman bankruptcy.

While the current combination of an “everything” asset-price bubble and a prolonged period of reckless lending would seem to make a Minsky moment inevitable, the timing of that moment is always difficult to predict. However, there is .......

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