Beware of the Minsky Moment

Overconfidence - Cat Quote

Kitteh Choose Your Own Adventure

I recently had knee surgery to repair a torn meniscus and partially torn ACL. I’d previously torn my ACL and had a pretty good idea in my mind of how this surgery would go. After all, the last time I had knee surgery, I was on crutches for a month and in rehab for six months. I thought that I’d be experiencing the same type of recovery.

Yet, when I got home after the outpatient surgery, I wasn’t really in much pain. I didn’t need painkillers, even though the doctor had prescribed me a bucket full of Vicodin. In 24 hours, I was up and walking, albeit not particularly well. After 48 hours, I wrote my parents, explaining that, until that point, it had been a “relative walk in the park.”

At 72 hours, I was allowed to disconnect the machine which had pumped ice water around my swollen kneecap and the three incision points where the doctor had gone in and shaved off the torn meniscus and cleaned up goodness knows what else inside my knee. I felt fine. I had even showered a couple of times without incident and my limp wasn’t nearly as pronounced as it had been 24 hours after the surgery.

I had a serious case of cabin fever. I’d been laid out horizontal for three full days. My wife suggested that we go grab some supplies at Petsmart for the dog and to the local Starbucks and grab a coffee. It sounded like a fine idea to me.

Off we went. I sat in the passenger seat and enjoyed just being out of the house. I didn’t actually go inside the Petsmart. I’m not that dumb. We did go inside Starbucks and sat there for about 45 minutes. Slowly, surely, my knee started throbbing. By the time we’d finished our coffees, I was ready to go home.

By the time we got home, I was in some serious pain and my knee was almost immovable. It had swollen up, and I was seriously considering taking a Vicodin. After a couple of Advils, the pain subsided some, but even a day later, I was still on the futon, barely able to move. It was like I’d regressed to the moment when I came home from the hospital.

I’d been overconfident. I’d become cocky and figured I could go out. When my knee started aching, I figured I could tough it out.

I had the surgery equivalent of what is known in investing as a “Minsky Moment.” Named after economist Hyman Minsky, the “Minsky Moment” is the point at which investment markets collapse because people have become overconfident, leveraged to the hilt, invested in whatever the hot investment of the moment is, and someone realizes that there is no next bigger fool to sell to. Selling quickly becomes panic selling, and people are forced to sell their assets at discounted prices to cover their investing profligacy.

I can imagine a 17th century Monkey Brain-induced Minsky Moment.


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YOU: “Well, I love her, but a hundred thousand dollar tulip? Do you think this will convince her to marry me? I don’t have that kind of money!”

MONKEY BRAIN: “MORTGAGE HOUSE! TULIPS WOMAN’S BEST FRIEND.”

Two months later…

YOU: “The tulip died! And I have this huge mortgage! What do I do?”

MONKEY BRAIN: “HOCK KIDNEY!”

It’s very easy to fall into the trap of thinking that life is smooth sailing and nothing could ever go wrong. You got a raise last year, you have the house, the family, the white picket fence, the 2.4 children, and are the spitting image of a stereotype of Americana. You take out a big mortgage and buy a huge house because the mortgage lender tells you that you can borrow 4 times your income and while, somewhere deep down inside, it dawns on you that the lender has a conflict of interest, you don’t let that bother you. Why would the raises stop? Why wouldn’t the good times keep on going? Why won’t the market keep going up? Doesn’t real estate always go up?

There are two predominant biases that Monkey Brain uses to allow us to slip into complacency in believing that the future will be just like a selected image of the present:

  • Recency bias. We look at the most recent past and extrapolate the rest of our futures based on what just happened to us. Got a raise? You’ll get a raise every year for the rest of your life! We forget about the times when we were just starting out or when we faced layoffs, preferring to lassiez les bon temps rouler.
  • Internal locus of control. When we believe that we control all of the outcomes in our lives, we exhibit an internal locus of control. While having an internal locus of control is a good thing, as it prevents us from feeling we’re victimized all of the time, having too strong of an internal locus of control can make us feel invincible and cause us to discount potential negative outcomes in our lives.

When the housing market collapsed in the late 2000s, many households had their own personal Minsky moments. Stuck in adjustable rate loans, they faced either foreclosing or short selling their homes or selling discounted assets – namely, investments which had dropped in the market concurrently with the collapse of housing prices – to cover the mortgage. These people had extrapolated a continued rise in real estate prices, markets going up and up and up, and a continually improving personal financial situation, and when their personal black swans appeared, they were caught wholly unprepared and forced into panic sales.

How you deal with potential downsides is the difference between optimism and overconfidence. Optimism is almost a requirement for investing. You invest in the markets, in rental properties, in starting up a small business because you believe that the value later will be greater than the value now. Otherwise, you’d be overly conservative and keep everything under the mattress or in CDs (which happens often to combat veterans). We delay gratification and don’t buy the 183” flat screen television now because we believe we’re actually going to be around and able to enjoy things later on in life. Otherwise, we’d live a purely hedonic lifestyle and never concern ourselves with what comes in the morrow.

When we become overconfident, though, we fail to lose our anchoring in the downsides that reality can present. Today is great and so tomorrow will be great and the day after that will be greater still. Overconfidence takes our risk meter, throws it on the ground, and stomps a mudhole in it (bonus points for the commenter who can tell me who coined the term “stomp a mudhole and walk it flat”). It causes us to think that, yes, while today, our mortgage payment may represent 40% of our take-home pay, in two years, it will be 20% of our take-home pay and doesn’t acknowledge the idea that there might be layoffs, furloughs, or a drop in real estate prices.

How do you prevent a personal Minsky Moment from happening?

  • Wait 30 seconds before trying to extrapolate into the future. Research shows that the recency effect can be dulled with just 30 seconds of waiting, allowing our frontal cortex to take back over and remind us of the whole picture.
  • Ask what could go wrong. When we ask ourselves contravening questions about our beliefs about the future, we are forced to acknowledge alternative realities.
  • Get an outside opinion on the future. Talking to someone who is not emotionally invested in your future what is happening will provide objectivity to the decision-making.
  • Ask what else you could be doing with the money you’re committing. Frame up the decision as “I could spend X now and have Y, or I could spend $0 now and have Z later.” By incorporating spending nothing now, you’re creating a mental alternative to a current possibility and forcing yourself to think about future spending and decisions. It also enables you to get out of a potential rut in thinking that causes you to believe that you only have one choice. You always have a choice.

It’s easy to allow Monkey Brain to snowball emotions and sneak in overconfidence into your decision-making. If you go along with him, though, you’ll be committing yourself to a situation where the best-case scenario has to work out for everything to be OK. That’s a tough and stressful way to live. You’re serving yourself better by being in a position to take advantage of other people’s Minsky Moments; there’s a buyer for every fire sale.

Have you ever had a personal Minsky Moment? Tell us about it in the comments below!

Around a year ago, I wrote about how to plan for a year-end bonus before you received it. If you haven’t read it, go check it out!

About Jason Hull, CFP®

Jason Hull, CFP®, is the Chief Technology officer of myFinancialAnswers, an online comprehensive financial planning service.

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