What’s Liquidity and Why Do We Need It?

Concern about a thing called liquidity has become one of the biggest obstacles to reforms aimed at making the U.S. financial system more resilient. Wall Street banks say that new capital requirements or constraints on speculative trading will cause it to dry up. They warn of dire consequences.

They’re wrong: At the very least, they’re exaggerating the problem. To see why, consider what this magic substance actually does. Once you understand that, you see that more liquidity isn’t always better -- and it’s possible to have too much.