Is This Another Minsky Moment?

I was recently asked to share views on Silicon Valley Bank’s collapse with some Morningstar Indexes colleagues. By the time of the meeting one week later, the list of troubled financial institutions had grown—Signature Bank, Silvergate, Credit Suisse, and First Republic—and I was getting messages of reassurance about my 401(k) assets at Charles Schwab. How many more dominoes are yet to fall?

Fifteen-year-old memories are flooding back to me. There was the Bear Stearns’ hedge fund collapse in July 2007, then a September bank run on Britain’s Northern Rock that I followed obsessively while on a business trip to London. By the end of 2008, Washington Mutual and Lehman Brothers had bitten the dust, and government rescue packages were required across the system. (The SVB crisis, the joke goes, has turned venture capitalists into venture socialists).

Remember how the 2007-08 banking troubles snowballed into a global financial crisis and the Great Recession? US automakers needed bailouts. Iceland, "the country that became a hedge fund," imploded, and the eurozone struggled for years to revive its PIIGS, a cruel acronym for the fragile economies of Portugal, Ireland, Italy, Greece, and Spain. Property markets across the globe took years to recover. The human toll of those years, which evoked the 1930s, has been blamed for a transnational wave of populist politics.

Will the current banking crisis metastasize? Or will it be contained like the US Savings & Loan failures of the 1980s, the Swedish banking crisis of the early 1990s, or the bankruptcy of Orange County, California in 1994? (Google them.)

While the path forward from here will only be obvious in retrospect, it feels to me like another "Minsky moment." Hyman Minsky, the mid-20th century economist who was rediscovered during the global financial crisis (then promptly forgotten again), studied boom and bust cycles. Good times lead to bad times, in Minksy's observation, as euphoric market participants assume the party will never end. They load up on risk, neglecting things like valuation, diversification, and downside management. Human nature being what it is, we try to keep up with the Joneses. That's especially true for those of us with short-term incentives. "As long as the music is playing, you've got to get up and dance," said former Citigroup boss Chuck Prince in 2007 before his bank got ensnared in the global financial crisis. Then the music stops. Or the punchbowl is removed. Or the tide goes out. Choose your metaphor.

Interest rates play a leading role in today's story, as they often do. Years of ultra-low borrowing costs after 2008, lowered again at the onset of the pandemic in 2020, undoubtedly fueled speculative excess. Money poured into FANG stocks—an acronym first coined in 2013 in reference to the high-flying tech shares of Facebook (now Meta), Amazon.com, Netflix, and Google (now Alphabet), later adjusted to include Apple and Microsoft—and Tesla saw a meteoric rise. Cryptocurrency, venture capital, and thematic investments all soared. Message boarders, many of them flush with "stimmies"—pandemic-era government stimulus checks—created the truly bizarre phenomenon of meme stocks. Then, generationally high inflation led to steep rate hikes in 2022. Stocks, bonds, and digital assets all plummeted. The chips continue to fall.

I've now been through a few cycles and agree with Mark Twain that "History never repeats itself, but it does often rhyme." I started my career during the late-1990s era of "irrational exuberance," when "eyeballs" were cooler than earnings. After the dot-com bubble burst, we saw a bear market, a recession, and investment debacles like Enron, WorldCom, and Tyco. Then, the Federal Reserve cut rates down to 1% in 2003, and it seemed like everyone was getting NINJA loans (no income, no job, no assets) or becoming a real estate agent. While the financial system was engineering now infamous instruments like collateralized debt obligations, the hottest investment theme was BRICS, for the promising emerging markets of Brazil, Russia, India, China, and sometimes South Africa. That one didn't age well.

As British chancellor before the global financial crisis, Gordon Brown pledged to end "boom and bust." It was a pipe dream. Minksy taught us that economic cycles are fundamentally rooted in human behavior. Because good times sow the seeds of downturns, no economy or investment only goes up. See: Madoff fund.

What's reassuring is that economies and markets have taken lickings before and kept on ticking. The cautious (or curmudgeonly) may even view crises as having a cleansing effect. "Bear markets exist to destroy the stupidities of the previous bull market," said investor Ralph Wanger.

Whether Silicon Valley Bank is aberration or harbinger, it offers important lessons. Stay diversified. Don't reach for yield and neglect risk. Maintain a "fortress balance sheet," in the phraseology of Jamie Dimon, CEO of JPMorgan Chase, a bank that survived the global financial crisis and thrived thereafter.

While timing the market is folly, cash is king. That's especially true in a crisis. Note the lineup for liquidity outside the doors of Berkshire Hathaway. For those of us without Warren Buffett's $35 billion cash pile, it helps that, for first time in 15 years, cash instruments actually provide some income. Thanks, higher interest rates!

What's the outlook for investors? The future is inherently unknowable. History is a useful guide, but we all know the past isn't prologue. Often the best course of action is no action at all. Investors who trade the least often do the best. One reasonable response to the SVB blowup is to accept the ups and downs that Minsky observed and follow the Zenlike wisdom of "Don't just do something, sit there."