The breakdown was fundamentally a liquidity crisis, and liquidity was easily restored in several ways the New York banks issued their own liquidity through a clearing house one massively powerful financial institution, J.P. Morgan, bought up collapsing shares, and thus reversed a market panic and a scramble for liquidity and European central banks supplied gold to the American market.

The fund's objectives, typically, are those of (a) maximizing risk adjusted returns, (b) security of capital and (c) liquidity, and their respective attitudes to risk.

Suddenly, as today, even big banks did not trust each other. The breakdown was fundamentally a liquidity crisis, and liquidity was easily restored in several ways the New York banks issued their own liquidity through a clearing house one massively powerful financial institution, J.P. Morgan, bought up collapsing shares, and thus reversed a market panic and a scramble for liquidity and European central banks supplied gold to the American market.

Furthermore, ample worldwide liquidity and the rise of other commodity prices induced market speculators to buy into oil futures.

Non EurepGAP compliant suppliers therefore even risk losing domestic market shares.

While there is a risk of market failure, it needs to be weighed against the risk of government failure.

But now it appears that, despite all this, we still have not had enough central planning in finance. For, even as the central banking authority administered the price of liquidity, the price of risk was left to the tender mercies of the market.

First, normal bankruptcy rules don t apply to repos. Second, much repo financing flows into large risk taking financial firms like MF Global, Lehman, and Bear Stearns through money market funds, which must invest very short term, because their depositors want immediate liquidity.

This was how central banking got started in the first place letting the market and the market alone determine the price of liquidity was judged too costly for the businessmen who voted and the workers who could overthrow governments. Now it looks as though letting the market alone determine the price of risk is similarly being judged too costly for today s voters and campaign contributors to bear.

The proposals that the SEC rejected were aimed at making money market funds more robust by requiring that each fund maintain capital reserves or let its value float and not be rounded up to reflect its true, underlying risk. The proposal would also have required that money market funds hold back a fraction of some redemptions, thereby making investors take some risk that funds might not have complete transactional liquidity if their investments weakened.

Critics might cite the moral hazard risk generated by liquidity support. But a well designed framework that offers swap lines only to well qualified emerging economies and only temporarily would diminish this risk substantially.

Projects in this field include physical market development enhancement of market infrastructure facilitation of private sector initiatives and commodity price risk management.

Liquidity position

Liquidity policy

This trend would continue with the introduction of the Euro and the creation of a much larger market with greater liquidity, stability and visibility.

Is Liquidity Enough?

The Liquidity Puzzle

5. Liquidity position

Partnerships of this sort involve risk and cost sharing and considerations of market access and power.

Fourth, the role of rating agencies needs to be rethought, with more regulation and competition introduced. Finally, liquidity risk should be properly assessed in risk management models, and both banks and other financial institutions should better price and manage such risk most financial crises are triggered by maturity mismatches.

It takes liquidity to make a market successful, and it can be difficult to get a new one started until it achieves a certain critical mass. The problem may be that there are not many investors who want to take a long position on oil and Nigerian credit risk simultaneously.

The Liquidity Time Bomb

However, countries could face abrupt changes in the cost and availability of liquidity when unexpected events triggered shifts in market sentiment, creating a strong need for additional reserves.

In the early 1990 s, policymakers, market participants, and economists alike simply assumed that the European Community s 1992 program the legislative framework for the single market, and thus for a single capital market would create a new reality, within which the single currency would work its magic. From this followed an official obligation to treat all types of risk in the monetary union bank risk or government risk as identical.

What determines a liquidity crisis?

This is the paradoxical result of the policy response to the financial crisis. Macro liquidity is feeding booms and bubbles but market illiquidity will eventually trigger a bust and collapse.

The major problem with these flows was volatility, and was characterized by heavy concentration on the most mature markets with a large stock market capitalization and high levels of liquidity.

G. Liquidity available cash versus liabilities

The Treasury bills would be assigned a zero risk rating by the authorities and treated as the highest quality collateral for repo operations at the ECB. nbsp The banking system has an urgent need for risk free liquid assets. Banks are currently holding more than 700 billion of surplus liquidity at the ECB, earning only one quarter of 1 interest. nbsp This assures a large and ready market for the bills at 1 or less.

The Treasury bills would be assigned a zero risk rating by the authorities and treated as the highest quality collateral for repo operations at the ECB. The banking system has an urgent need for risk free liquid assets. Banks are currently holding more than 700 billion of surplus liquidity at the ECB, earning only one quarter of 1 interest. This assures a large and ready market for the bills at 1 or less.

Commodity exporters in developing countries should be given market access and helped to develop risk management strategies and flexible compensatory schemes.

Thousands of children are annually taken from social risk situations and are prepared so that they can face labour market competition.

The problem is that the Fed s liquidity injections are not creating credit for the real economy, but rather boosting leverage and risk taking in financial markets. The issuance of risky junk bonds under loose covenants and with excessively low interest rates is increasing the stock market is reaching new highs, despite the growth slowdown and money is flowing to high yielding emerging markets.

Statement IV. Liquidity position at 31 December 1997

2. Cash flow and liquidity . 13 18 19

But another Fed faction led by Governors Jeremy Stein and Daniel Tarullo argues that macro prudential tools are untested, and that limiting leverage in one part of the financial market simply drives liquidity elsewhere. Indeed, the Fed regulates only banks, so liquidity and leverage will migrate to the shadow banking system if banks are regulated more tightly.

For more than half that time say, 85 years it has been accepted doctrine that markets are also not to be trusted even in normal times, lest doing so lead to a liquidity squeeze or to an inflationary bubble. So, central banks must set the price of liquidity in the market day in and day out.

Banks known to be healthy can borrow at much less than 5.25 . But banks facing possible liquidity problems which the Fed wants to be able to borrow at 5.25 are borrowing from the Fed itself at 5.75 , as are a few big banks that want more liquidity but don t believe they could get it without disrupting the market.

In short, though central banks creation of macro liquidity may keep bond yields low and reduce volatility, it has also led to crowded trades (herding on market trends, exacerbated by HFTs) and more investment in illiquid bond funds, while tighter regulation means that market makers are missing in action.

Like banks, all these financial institutions are subject to liquidity or rollover risk the risk of going belly up if their creditors do not rollover their short term credit lines. But, unlike banks, they do not have the safety net implied by central banks role as lender of last resort.

Surprisingly, the bond market still seems almost oblivious to this risk. But holders of US debt worldwide have every reason to be concerned.

Statement IV. Liquidity position (consolidated) at 31 December 1997

He or she should not attempt to centralize information, but rather to make it flow more smoothly. Call it information liquidity, akin to financial liquidity.

The banks are now content to leave those funds at the Fed, where they earn a mere 0.25 because they are risk free, completely liquid, and unburdened by capital requirements. The alternative is to lend commercially at relatively low interest rates, with less liquidity, more risk, and the need to provide capital.

Unlike the West s QE enabled market manipulation, which works circuitously through central bank liquidity injections, the Chinese version is targeted more directly at the market in distress in this case, equities. Significantly, QE is very much a reactive approach aimed at sparking revival in distressed markets and economies after they have collapsed.