Systemic Liquidity Risk and Bipolar Markets: Wealth Management in Today's Macro Risk On/Risk Off Financial Environment

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Introduction

The events of 2007/8 pulled back the magician’s curtains and revealed a rather shocking truth about the global financial system – markets can seize up and become completely illiquid. Although previous generations may have experienced similar episodes of systemic illiquidity, in the fall of 2008 the magnitude of the near meltdown came as a traumatic shock to most working in the financial world as well as those beyond. Even for assets such as short-term commercial paper and money market instruments, the liquidity which had been taken for granted completely evaporated. During Q4, 2008 the only asset class for which there was real liquidity was short-term government securities of very highly rated sovereigns. Banks did not want to deal with each other and most asset managers refused to purchase assets, where the risk of not knowing when they might be able to sell them again reflected a profound crisis in confidence regarding the efficacy of markets and the liquidity of market instruments.

At the limit there is ultimately a fundamental paradox regarding liquidity which is that when it is most required it is likely to be non-existent. John Maynard Keynes had a keen eye for noting paradoxes at the root of economic behavior, and made the following observation regarding what today would be called systemic liquidity. [1]

Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of ...