Don’t Wait Too Long to Leave the Party

Liquidity is the ultimate paradox in finance. It’s always there when you don’t need it and never there when you need it most. The reason is crowd behavior, or what mathematicians call hypersynchronicity (a fancy word for everyone doing the same thing at the same time).

When markets are calm, no one wants liquidity because investors are happy to hold stocks, bonds, currencies, commodities and other assets in their portfolios. As a result, there’s plenty of liquidity on offer from bank lenders and very few takers.

The opposite is true.

In a financial crisis, everyone wants his money back at once. Stocks are crashing, bonds are crashing, margin calls are streaming in and everyone is trying to sell everything at once to avoid losses, meet margin calls and preserve wealth.

In those circumstances, there’s not enough liquidity to go around. Banks, and ultimately regulators, decide who lives and who dies (financially speaking) by offering liquidity or cutting it off.

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