Financial markets periodically experience what Paul McCulley of PIMCO dubbed a ‘Minsky Moment’ — that is, a collapse in asset values caused by overconfidence and excessive risk-taking. Named after economist Hyman Minsky and first used to describe the 1997 Asian financial crisis, these events are characterised by their speed, scope and synchronicity.
The 2008 global financial crisis is another example of Minsky Moment. Investors suddenly realised that mortgage-backed securities were systematically mis-priced, and this triggered a cascade of events so severe that governments had to intervene. While there were many contributing factors, one root cause was that the credit risks associated with mortgage-backed securities were not readily transparent or easily analysed.
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As our understanding of global warming advances, some people are continuing to sound the alarm about a potential climate-driven Minsky Moment — a scenario where asset prices plummet and capital markets collapse due to climate change. Climate change does pose a financial risk for investors, but it is unlikely to produce a Minsky Moment. This is because Minsky Moments come from sudden and widespread changes in asset valuation assumptions, whereas climate change affects the real economy. While it may be useful to link climate change to Minsky Moments to spur people to act, it may lead them to take the wrong kind of action.
Climate change is measured by changes in 10-year (or longer) average temperatures and rainfall. Long-term rolling averages do not move quickly, different regions change at different speeds, and the global warming trend is no secret. These are not the sort of conditions that lead to a Minsky Moment.
This isn’t to suggest that climate change won’t create investment losses — it certainly will. Some assets will become stranded, some regions will experience significant economic disruption, and some industries will face fundamental challenges. However, these losses are more likely to resemble the normal process of creative destruction that characterises market economies rather than the synchronised collapse that defines a Minsky Moment.
The insurance industry illustrates the impact of climate risks. For decades, insurers have been dealing with climate-related losses from hurricanes, floods, and wildfires. While these events have created significant — and increasing — costs for insurers, they haven’t triggered an industry-wide crisis because losses are geographically diverse, the risks are shared with reinsurers, and the risks are continuously repriced through premium adjustments.
Likewise, globally diversified investors can avoid a climate Minsky Moment. This doesn’t mean, however, that they will be able to avoid all climate-related losses. Even well-diversified portfolios will likely experience lower returns as adaptation costs reduce productivity and extreme weather events destroy physical assets and infrastructure. The risk of a capital market collapse is low, but the risk of real economic impact is high.
The distributed nature of climate change allows investors to reallocate capital in ways that financial shocks do not. Investors are already evaluating the risk of climate change, and they will continuously reprice that risk as the future unfolds. Thus, the price of individual assets and securities may change significantly in response to changes in idiosyncratic risks, but the value of a well-diversified portfolio will change more gradually in response to changes in the overall systemic level of risk.
Overconfidence is a contributing factor to Minsky Moments, and we must be careful not to be too sure that climate change will happen gradually. Long-term global averages change slowly, but that doesn’t mean that shorter-term regional patterns won’t change more quickly. Also, we must recognise there may be ‘climate tipping points’ that set the world on a certain course. But even if we cross a tipping point such that all the ice in Antarctica will eventually melt, it will still take centuries for that to happen.
There are important implications here for investors. Rather than preparing for a climate-driven Minsky Moment, investors should focus on building resilient portfolios. This means maintaining geographic diversification, avoiding excessive concentration in climate-vulnerable industries, and ensuring sufficient liquidity to reallocate capital in response to both short-term shocks and long-term trends.
For policymakers and regulators, this suggests that climate risk management should focus on economic resilience rather than preventing a liquidity event. The greater threat isn’t capital market dysfunction but rather the cumulative impact of persistent challenges that add up to a drag on real economic productivity.
Climate change is unlikely to manifest as a Minsky Moment for well-diversified investors. Investors should not take too much comfort in this forecast because it is highly likely that climate change will be a long-term drag on returns. Having the right understanding of the fundamental nature of climate risk is crucial for developing appropriate portfolio risk management strategies and for avoiding preparing for the wrong kind of crisis.
