The Minsky/Kindleberger Sequence of Events That Characterize Stock Market Booms and Busts

The Minsky/Kindleberger sequence has some fairly defined steps leading from booms to busts. When looked in the context of current events you will see a startling coincidence.

The biggest objection to this sequence is to say that things are not that simple. And that is true as far as it goes. But just because something may appear simple doesn’t mean it isn’t true. Even Albert Einsterin once said that, “everything should be made as simple as possible, but not simpler”.

So as to not labor the point about simple or not, here is a brief discussion of my view of the M/K sequence and some references on how this may playout in real time.

The Minsky/Kindleberger Sequence (1)

Hyman Minsky and Charles Kindleberger proposed various scenarios for speculative bubbles and the ensuing financial crises. Some steps in the sequence beginning with an exogenous event such as a pandemic and culminating in a market collapse are summsrized in the following discussion.

1. The market rise starts off because of some exogenous shock.

Wars, technological,or natural discoveries, or pandemics are examples ofsuch events. The shock creates new opportunities for profit, and a boom is engendered.

2. The boom is nurtured by an expansion of bank credit

This expands the money supply. Alternatively, the velocity of circulation increases. This velocity is a measurement of the numberr of times money moves from one entity to another.According to Investopedia, it’s the rate at which consumers and businesses in an economy collecttively spend money.

3. Increased demand pushes up the prices of goods, services, and financial assets (inflation)

New profit opportunities are found, and confidence grows in the economy. Multiplier and accelerator effects interact, and the economy enters a “boom or euphoric state.” At this point overtrading may take place. This kind of overtrading can take the form of pure speculation, that is over-emphasis on the acquisition of assets for capital gain rather than income return from productive opetations.. Overestimation of prospective returns by companies leads them to seek returns from merges and acquisition (M&A), stock buybacks, and speculation..Excessive gearing involving the imposition of low cash requirements on the acquisition of financial assets through buying on margin, by installment purchases, low mortage rates for real estate, etc.

4,. Neophytes enter the market

Attracted by the prospect of large capital gains for a small outlay, neophytes become numerous in the market. This activity assumes a separate abnormal momentum of its own. The 2021 meme stock frenzy is a good example of this type of momentum. GME driven up to obsecene heights when uninformed investors took long positions to counter the short sellers. The “rich Wall Street traders” were blamed for this event. However, these short sellers were selling because GME was a dog stock with little if any intrinsic value. Short squeezes buying made the situation worse and ultimately lead to a fall in the price og GME.

Insiders recognize the danger signals and move out of securities into money. ( See prior sntence)

5. A financial distress period sets in as the neophytes become aware that, if there is a rush for liquidity, prices will collapse.

The race to move out of securities gathers pace.

6. Revulsion against securities develops as banks start calling in loans and selling collateral.

The current concern over and insolvency of Silicon Valley Bank is an example of this sort of insolvency. Silicon Valley Bank’s failure is a warning for the Fed. This isn’t to say we will see a 2008 style outlier event. But at some point losses will mount in those financial institutions impacted by the recent and sudden rise in interest rate. Institutions that hold treasuries at varying maturities can weather longer term economic reversals provded they have sufficient liquidity. The problem surfaces when a bank whose capital is held in longer dated maturities needs present day cash. When rates rise, the value of their bond portfolio declines. This is a problem. If the bank needs cash, it may need to sell it’s bond holdings at the current reduced price. If the bank can wait to maturity, they will receive the full value of their bonds. However, if you have a 10 year bond with a 4% coupon rate and rates rise, you bond will fall in value. Its hard to wait 10 years when you need the money to pay your creditors today..

7. Panic sets in as the market collapses

Question arises as to whether the government or Central Bank should come in and act as a lender of last resort in what has been recently described as a “lifeboat operation.. “ U.S. lawmakers met Fed, FDIC to discuss Silicon Valley Bank’s collapse, Coindesk reports White House and Yellen confident they can handle it.

As of today, Janet Yellen has come out to say that a bailout of SVB in not in the cards.

I’m not implying that a market crash is imminent. Markets are too random to be a copy of prior occurances. But in every past market bust these steps have played out to one degree or another- 1965…1976…1982…1987…2000…2008…2023 ?

Final Thoughts

Market booms and busts generally start with some unanticipatred event and follow a consistent pattern of central bank intervention leading to low interst rates, inflation, speculation, over valuation, uncertainty, fear and collapse.

Some of these cycles are moderate. Some are not. How and when this cycle will play out is anyone’s guess.

My best solution is to review your portfolio with your financial advosor and make sure you have a sufficient cash cushion in place to weather any storm.

Be safe and trade carefully.

Do you have any questions about getting started in Options trading? Share in the comments so I can help.


(1)A Minsky-Kindleberger Perspective on Financial Crisis – https://www.tandfonline.com/doi/abs/10.2753/JEI0021-3624460220

Investopedia -https://www.investopedia.com/

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