Wednesday, November 16, 2016


Stan Fisher was at Brookings yesterday.  Subject?  Market liquidity.  I urge you to read the text as I think it is one of the most important topic that we shall face in the coming months.  I wouldn't dare to paraphrase Mr. Fisher nor disagree with him but the latter course, if one were bold or dumb enough to take it is not really necessary in this case.  I must say, Mr. Fisher is like an Alan Greenspan squared from the standpoint of trying to determine his real position on a subject.  The difference is he lays out the arguments so clearly and consistently on both sides, dropping hints here and there, leading the listener or reader to what appears to be the "Ah Ha" moment only to remove it in the next three lines.
It's really a terrific piece for those who have an interest in these things.

In the end, Stan reaches the opinion that liquidity in today's markets is "adequate."  Of course what "adequate" really is is not fully understood.  His arguments are data driven but he freely admits that while there may be more trading today (volume) there is also much more product that ten years ago.  And while there are "flash events" they seem to have been handled by the system and while there is undoubtedly less market action by banks the slack has probably been taken up by other players such as hedge funds.  All well and good and supported by, as mentioned, the data.  Mr. Fisher has said precisely what the Vice Chairman of the Fed should say, but I suspect--and one finds it in the tone of this speech--that he has not said it all.

In the past eight years, there really has been one way traffic in the markets and while there have been a few twists and turns, the general trend has been towards massive increases in debt both governmental and sovereign, declining interest rates and reasonable if not low volatility except for brief periods of disorder and "flash events."  Not to be forgotten is that inflation despite monetary creation on the part of central banks has for all practical purposes been non-existent due to a variety of factors not the least of which have been low energy prices and a severe decline in economic growth in mature economies due primarily to governmental policies.  That is about to change or at least the markets, over the past month or so seem to believe that things are changing.

It is one thing to say that in such a benine period what we have is doing just fine and quite another thing to expect that markets will react in the same manner in a period of heightened and continuous stress.  Liquidity is never really an issue unless you need it...and then it is the only issue.  And where I would take exception to Stan's analysis is in this:  Paul Volker once said, "Banks are different." Banks and certain street firms were true market makers.  Solomon Bros. was probably the best of the lot.  In any issue in which they were a market maker there was always a might not have liked where it was but there was always a bid.  If you needed to move Treasuries, there was always a bid from houses like J.P. Morgan, and Bankers Trust and others.  Hedge Funds are not banks.  There will not always be a bid and that becomes important not in times such as we have just experienced but in the future which by definition is unknown but about which warnings are being issued by the very people who might require the liquidity and...which is the true irony of the situation...may themselves be creating the need through the fear of circumstances which few of them have experienced.  Stan mentioned in his talk that inventories at reporting institutions are down nearly 50% in the past eight years.  Yet the amount of debt outstanding has doubled.  If the VIX is any indication, risk has increased.  So has the chance of a "tail event" which is the new catch-word of today.  It seems that "Black Swan" tended to scare the crap out of people.  By definition, you cannot prepare for whateever you want to call it.  But you may be able to mitigate its consequences.  We weren't ready in 2009.  For a variety of reasons 2017 may be a really rough ride.

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