Corzine and the Liquidity Trap

Smart Roger Lowenstein take on liquidity’s submerged risks:

Time and again, otherwise canny investors fall for the salve that in a liquid market, they can always get out, therefore what’s the problem? At Lehman, in the mid 2000s, executives took comfort in the notion that that the bank was in the “moving business” not the “storage business.” Then, the mortgage market froze, and everyone was in the storage business.

Liquidity is a backward-looking yardstick. If anything, it’s an indicator of potential risk, because in “liquid” markets traders forego trying to determine an asset’s underlying worth – – they trust, instead, on their supposed ability to exit. Investors now in low-yielding U.S. Treasury bonds may, one day, discover this lesson for themselves.

It’s hard to overestimate the extent to which the siren of liquidity has seduced even ordinary Americans. During the housing bubble, anyone who took out a mortgage they couldn’t afford, upon advice they could always refinance, was tacitly assuming they could trade their old loan for a new one. They were counting on continued liquidity in the mortgage market–and so were the banks that lent them the money.

via Corzine Forgot Lessons of Long-Term Capital: Roger Lowenstein – Bloomberg.


  1. This is also a theme that Bookstaber covers well. Correlated markets that cause huge liquidity problems where no one saw them coming.

  2. I take his point but it's also just pure punditry to wait til something fails and say "something is wrong with the way they were thinking". What is the alternative to relying on market liquidity and what does the economy look like if we all implement that alternative? It looks like Q408, Q1 09. And that ain't good. Pundits never get into that.