We’re seeing more and more news on this:
It’s very possible that a liquidity panic could lead to the next financial crisis, says The New York Times.
“Liquidity” refers to how easy it is to convert assets to cash. You can quickly get cash from a savings account; it may take awhile to sell your house.
William Gross, referred to by some as the “king” of bond investors, this summer wrote about “possible exit and liquidity problems in future months and years.”
He’s referring to the potential difficulty of finding buyers for some bonds when an individual or a company wants to sell, causing the bonds to be sold at fire-sale prices.
The potential for such a crisis isn’t restricted to big pension funds and wealthy investors.
“Mutual funds, hedge funds and ETFs are part of the ‘shadow banking system,’ where these modern ‘banks’ are not required to maintain reserves or even emergency levels of cash,” Gross wrote in a letter to investors.
“Since they in effect now are the market, a rush for liquidity on the part of the investing public, whether they be individuals in 401(k)s or institutional pension funds and insurance companies, would find the ‘market’ selling to itself with the Federal Reserve severely limited in its ability to provide assistance.”
Not everybody is convinced a liquidity crisis is upon us. Matt Levine, a columnist for Bloomberg View, says it’s a "liquidity illusion,” which he defines as a narrative that “big investors buy a lot of bonds thinking that they’ll be easy to unload in a crash, but in fact they won’t be easy to unload, and there’ll be panicked fire sales that worsen the crash and lead to a real crisis.”
He says: “How is that illusion tenable when everyone talks about it all the time? What big investor is suffering from the liquidity illusion? Presumably not all the investors who are quoted constantly in stories about the liquidity illusion, right?”