Scarce Liquidity Is a Growing Risk

No one can predict how bad the next financial crisis will be. What’s certain, though, is that a lack of liquidity will make the fallout much worse.

Holders of securities, currencies and commodities need trading liquidity so they can adjust positions, raise cash to meet redemptions, reduce their risk, or limit losses. Yet they seem to anticipate more liquidity than there actually is. Outside of a few stocks, major currencies and some government securities that trade consistently in large volumes, few instruments are truly liquid. High trading volumes and low bid-offer spreads are misleading. Earlier this month, as political chaos gripped Italy, volumes shrank and the bid-offer spread tripled with alarming speed.