Markets are going to have to reprice lower as borrowers and
intermediaries figure out the real costs of liquidity, but a
move from current levels to more sustainable ones will be easier
and less costly than the ultimate blow-up should we return to
This is not to say the process is without risk: that’s
exactly the point. There is a transitional risk as we move from
a market in which publicly backed institutions like banks took
liquidity risk in larger size to one in which they must work out
a fair price to make borrowers and investors pay.
That is going to be a bumpy process, but financial markets
should be bumpy. You can have your bumps a little at a time, or
all at once, as in 2008. The former is preferable.
James Saft doesn’t miss the old days, when liquidity had no cost and thus was used and abused carelessly. He points to the abnormal levels of liquidity and calls them a “subsidy” benefiting only some financial intermediaries while putting the public at greater risk. It’s an interesting argument. Hit the link above to read more.