Social Europe

  • EU Forward Project
  • YouTube
  • Podcast
  • Books
  • Newsletter
  • Membership

Liquidity Helps Financial Market Participants, Not Businesses And Households

John Kay 1st December 2015

John Kay

John Kay

Nothing illustrates more starkly the difference between the preoccupations of financial market participants and the needs of businesses and households than the subject of liquidity.

Last week the Bank of England held an open forum to discuss what the financial sector contributes to the real economy, and I took part in a discussion on the role of liquidity. It began from a practitioner’s definition of liquidity: “The ease with which one asset can be exchanged for another.” Finance professionals bemoaned a decline in liquidity, blaming the global crisis and the subsequent intensification of regulation. In markets such as corporate bonds, they reported almost no liquidity at all.

But while the ease of exchanging one asset for another matters to traders, that is not the measure of liquidity that matters to savers. For them, security of their cash is crucial; they want to be able to take their money out of banks when they need it and they need to be sure that ATMs will continue to function.

Savers also need to be able to realise their assets in retirement and for big purchases. But they do not need a stock exchange in which shares are traded every millisecond. Their needs would be met adequately by a market that opened once a week. Perhaps once a month, or once a year, would do.

So focusing on the needs of savers and business rather than market participants leads to a different perspective on liquidity. Corporate bonds are long-term company obligations, mostly held by insurance companies and pension funds to meet their own long-term obligations. There is not much trade or liquidity in these markets because there is not much need for trade or liquidity in these securities.

The practitioners at the open forum worried that the absence of an active market damaged the process of “price discovery”. But “price discovery” seems to mean something different from “value discovery”, which is an estimate of the expected cash flows that holders will derive from the security over its life. “Price discovery” owes more to other traders’ expectations than fundamentals of valuation. To believe more can be learnt about the credit quality of a bond by stimulating trade in it than from careful evaluation of the circumstances of the issuer requires an unjustified faith in the “wisdom of crowds”. A lesson of the subprime mortgage fiasco is that an active market in securitised products is no substitute for careful assessment of the borrower’s capacity to repay.

Regulation of unit trusts and other open-ended investment products, and of insurance and pension funds, today imposes requirements for marketability far in excess of anything required by the underlying needs of savers. And the restrictions these obligations impose on investment choices damage the interests of the retail customers whom the rules were initially intended to help.

Regulators then fear savers might actually use the liquidity they are promised, but do not really need, by massive withdrawals from a single asset manager in which they have lost confidence. This fear is the basis of an argument for yet further regulation, involving the designation of large asset managers as “systemically important financial institutions”. And so the spiral of increasing regulatory complexity winds on.

Liquidity in financial markets is often equated to the volume of trade. But every financial crisis shows that such liquidity is liable to evaporate when actually required. An assurance that the funding requirements of businesses and households can be met is best achieved by a resilient, well-capitalised banking system and an asset-management sector focused on the long-term needs of both providers and users of capital. A market characterised by large trading volumes on low spreads serves the interests of market practitioners rather than their customers.

This column was first published in the Financial Times and on John Kay’s Blog.

John Kay

John Kay is Visiting Professor of Economics at the London School of Economics and a regular columnist for the Financial Times.

Harvard University Press Advertisement

Social Europe Ad - Promoting European social policies

We need your help.

Support Social Europe for less than €5 per month and help keep our content freely accessible to everyone. Your support empowers independent publishing and drives the conversations that matter. Thank you very much!

Social Europe Membership

Click here to become a member

Most Recent Articles

u4219834676d582029 038f 486a 8c2b fe32db91c9b0 2 Trump Can’t Kill the Boom: Why the US Economy Will Roar Despite HimNouriel Roubini
u42198346fb0de2b847 0 How the Billionaire Boom Is Fueling Inequality—and Threatening DemocracyFernanda Balata and Sebastian Mang
u421983441e313714135 0 Why Europe Needs Its Own AI InfrastructureDiane Coyle
u42198346ecb10de1ac 2 Europe Day with New DimensionsLászló Andor and Udo Bullmann
u421983467a362 1feb7ac124db 2 How Europe’s Political Parties Abandoned Openness—and Left Populism to Fill the VoidColin Crouch

Most Popular Articles

startupsgovernment e1744799195663 Governments Are Not StartupsMariana Mazzucato
u421986cbef 2549 4e0c b6c4 b5bb01362b52 0 American SuicideJoschka Fischer
u42198346769d6584 1580 41fe 8c7d 3b9398aa5ec5 1 Why Trump Keeps Winning: The Truth No One AdmitsBo Rothstein
u421983467 a350a084 b098 4970 9834 739dc11b73a5 1 America Is About to Become the Next BrexitJ Bradford DeLong
u4219834676ba1b3a2 b4e1 4c79 960b 6770c60533fa 1 The End of the ‘West’ and Europe’s FutureGuillaume Duval
u421983462e c2ec 4dd2 90a4 b9cfb6856465 1 The Transatlantic Alliance Is Dying—What Comes Next for Europe?Frank Hoffer
u421983467 2a24 4c75 9482 03c99ea44770 3 Trump’s Trade War Tears North America Apart – Could Canada and Mexico Turn to Europe?Malcolm Fairbrother
u4219834676e2a479 85e9 435a bf3f 59c90bfe6225 3 Why Good Business Leaders Tune Out the Trump Noise and Stay FocusedStefan Stern
u42198346 4ba7 b898 27a9d72779f7 1 Confronting the Pandemic’s Toxic Political LegacyJan-Werner Müller
u4219834676574c9 df78 4d38 939b 929d7aea0c20 2 The End of Progess? The Dire Consequences of Trump’s ReturnJoseph Stiglitz

KU Leuven advertisement

The Politics of Unpaid Work

This new book published by Oxford University Press presents the findings of the multiannual ERC research project “Researching Precariousness Across the Paid/Unpaid Work Continuum”,
led by Valeria Pulignano (KU Leuven), which are very important for the prospects of a more equal Europe.

Unpaid labour is no longer limited to the home or volunteer work. It infiltrates paid jobs, eroding rights and deepening inequality. From freelancers’ extra hours to care workers’ unpaid duties, it sustains precarity and fuels inequity. This book exposes the hidden forces behind unpaid labour and calls for systemic change to confront this pressing issue.

DOWNLOAD HERE FOR FREE

ETUI advertisement

HESA Magazine Cover

What kind of impact is artificial intelligence (AI) having, or likely to have, on the way we work and the conditions we work under? Discover the latest issue of HesaMag, the ETUI’s health and safety magazine, which considers this question from many angles.

DOWNLOAD HERE

Eurofound advertisement

Ageing workforce
How are minimum wage levels changing in Europe?

In a new Eurofound Talks podcast episode, host Mary McCaughey speaks with Eurofound expert Carlos Vacas Soriano about recent changes to minimum wages in Europe and their implications.

Listeners can delve into the intricacies of Europe's minimum wage dynamics and the driving factors behind these shifts. The conversation also highlights the broader effects of minimum wage changes on income inequality and gender equality.

Listen to the episode for free. Also make sure to subscribe to Eurofound Talks so you don’t miss an episode!

LISTEN NOW

Foundation for European Progressive Studies Advertisement

Spring Issues

The Spring issue of The Progressive Post is out!


Since President Trump’s inauguration, the US – hitherto the cornerstone of Western security – is destabilising the world order it helped to build. The US security umbrella is apparently closing on Europe, Ukraine finds itself less and less protected, and the traditional defender of free trade is now shutting the door to foreign goods, sending stock markets on a rollercoaster. How will the European Union respond to this dramatic landscape change? .


Among this issue’s highlights, we discuss European defence strategies, assess how the US president's recent announcements will impact international trade and explore the risks  and opportunities that algorithms pose for workers.


READ THE MAGAZINE

Hans Böckler Stiftung Advertisement

WSI Report

WSI Minimum Wage Report 2025

The trend towards significant nominal minimum wage increases is continuing this year. In view of falling inflation rates, this translates into a sizeable increase in purchasing power for minimum wage earners in most European countries. The background to this is the implementation of the European Minimum Wage Directive, which has led to a reorientation of minimum wage policy in many countries and is thus boosting the dynamics of minimum wages. Most EU countries are now following the reference values for adequate minimum wages enshrined in the directive, which are 60% of the median wage or 50 % of the average wage. However, for Germany, a structural increase is still necessary to make progress towards an adequate minimum wage.

DOWNLOAD HERE

Social Europe

Our Mission

Team

Article Submission

Advertisements

Membership

Social Europe Archives

Themes Archive

Politics Archive

Economy Archive

Society Archive

Ecology Archive

Miscellaneous

RSS Feed

Legal Disclosure

Privacy Policy

Copyright

Social Europe ISSN 2628-7641