Liquidity: Difference between revisions
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The ease with which one can buy or sell an [[asset]]. So a [[US T-Bill]] is very [[liquid]] — you can buy or sell any number in the blink of an eye; a power station in the lawless mountainous badlands of central Asia is very illiquid — it | The ease with which one can buy or sell an [[asset]]. So, a [[US T-Bill]] is very [[liquid]] — you can buy or sell any number in the blink of an eye; a power station in the lawless mountainous badlands of central Asia is very ''illiquid'' — it may take three years of [[due diligence]], all kinds of legal, regulatory and accounting engineering, and the conveyance of a few bags of cash in brown paper bags to local gentlemen in Kalashnikov-equipped Hiluxes. | ||
===Illiquidity=== | ===Illiquidity=== | ||
Liquidity is really a function of the ease with which demand and supply can be matched. It will always be a job with big, complex, privately held assets, but even | [[Liquidity]] is really a function of the ease with which demand and supply can be matched. It will always be a job with big, complex, privately held assets, but even usually liquid assets (like listed [[equities]]) can suddenly become illiquid. This could happen: | ||
*'''When the [[issuer]] is in trouble'''. Then, all the world’s a seller, and no-one is buying. Hence: liquidity zero. Sellers are stuck with assets they don’t want. | *'''When the [[issuer]] is in trouble'''. Then, all the world’s a seller, and no-one is buying. Hence: liquidity zero. Sellers are stuck with assets they don’t want. This kind of illiquidity is [[credit]]-related. | ||
*'''When the market is in trouble''': In 2007 the [[credit crunch]] was caused by reliable investors suddenly deserting the [[commercial paper]] market to conserve their own cash reserves | *'''When the market is in trouble''': In 2007 the [[credit crunch]] was caused by reliable investors (typically commercial and investment banks), spooked about their own capital positions, suddenly deserting the [[commercial paper]] market to conserve their own cash reserves, rather than anything specific to the AAA assets they were buying<ref>although the assets they were buying, notionally AAA rated [[asset-backed securities|asset-backed]] [[commercial paper]], were pants, and many of the [[CP]] buyers knew this, having structured them themselves</ref>. Thus the old saw: “don't use short-term assets (like commercial paper) to fund long-term liabilities (like mortgages)”. Not the great example, because there was an element of credit concern in the strike, but the point remains that illiquidity can be driven by ''[[lender]]'' credit weakness, not necessarily ''[[borrower]]'' credit weakness. | ||
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*[[Liquidity period]] | *[[Liquidity period]] | ||
*[[Illiquidity]] | *[[Illiquidity]] | ||
*[[Term]] | |||
{{ref}} | |||
Revision as of 08:14, 11 July 2018
The ease with which one can buy or sell an asset. So, a US T-Bill is very liquid — you can buy or sell any number in the blink of an eye; a power station in the lawless mountainous badlands of central Asia is very illiquid — it may take three years of due diligence, all kinds of legal, regulatory and accounting engineering, and the conveyance of a few bags of cash in brown paper bags to local gentlemen in Kalashnikov-equipped Hiluxes.
Illiquidity
Liquidity is really a function of the ease with which demand and supply can be matched. It will always be a job with big, complex, privately held assets, but even usually liquid assets (like listed equities) can suddenly become illiquid. This could happen:
- When the issuer is in trouble. Then, all the world’s a seller, and no-one is buying. Hence: liquidity zero. Sellers are stuck with assets they don’t want. This kind of illiquidity is credit-related.
- When the market is in trouble: In 2007 the credit crunch was caused by reliable investors (typically commercial and investment banks), spooked about their own capital positions, suddenly deserting the commercial paper market to conserve their own cash reserves, rather than anything specific to the AAA assets they were buying[1]. Thus the old saw: “don't use short-term assets (like commercial paper) to fund long-term liabilities (like mortgages)”. Not the great example, because there was an element of credit concern in the strike, but the point remains that illiquidity can be driven by lender credit weakness, not necessarily borrower credit weakness.
See also
References
- ↑ although the assets they were buying, notionally AAA rated asset-backed commercial paper, were pants, and many of the CP buyers knew this, having structured them themselves