Financial markets have experienced several episodes of “liquidity crises” over the past 20 years. One prominent example is the collapse of the Long Term Capital Management hedge fund in 1998. The recent market disruption brought about by the downturn in subprime mortgages also shares many features with liquidity crises. What is liquidity? Why does it sometimes seem that the market’s supply of it is insufficient? Can anything be done about it? In this article, Ronel Elul outlines some theories of market liquidity provision, how it breaks down in times of crisis, and some possible government responses.
This article appeared in the Second Quarter 2008 edition of Business Review.View the Full Article