BS: Global liquidity drought threatens another bloodbath in markets, warns top banker
Investors face a “painful” adjustment in a world of evaporating liquidity and higher U.S. interest rates that will prompt huge market swings with potentially catastrophic financial consequences, the Institute of International Finance has warned.
Tim Adams, the chief executive of the IIF, which represents the world’s biggest banks, described liquidity as the “top issue” at meetings of central bankers, chief executives and other financial institutions. He warned that regulations introduced in the wake of the 2008 crisis could potentially cause market gyrations larger than last October’s sudden crash in U.S. treasuries.
While Adams supports tougher rules that have made banks more resilient, he said a complex web of regulatory reform may have left them less able to respond to the next crisis.
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“There’s just less capacity for making markets,” he said. “Officials will say: we expect some volatility and this was part of this broader scheme of regulatory reform. But for the private sector there is this issue of: is the total effect of all of these various regulatory changes likely to produce outcomes larger than each individual regulatory reform and its consequences? The cumulative unintended could end up being much larger than the one-off intended — we just don’t know.”
Market liquidity, or the ease with which an investor can quickly buy or sell a security without moving its price, has evolved since the financial crisis. Investment banks, which traditionally supported liquidity in times of stress, have been shrinking their activities.
Corporate bond inventories have fallen by 75 per cent in the U.S. and 50 per cent in Europe since 2007, according to IIF data. While much of this has been driven by investment banks unwinding large credit books, regulation has also discouraged banks from holding large quantities of bonds that could help cushion violent swings in prices.
Adams said a “dramatic revolution” of the players and risks of market-making had also pushed risk “out into the shadows” of non-bank lending.
“We’ve rewired and reengineered the global financial regulatory system and as a result we’re having profound impacts on institutional arrangements. At the same time we’ve had this rapid change in benchmark prices such as a 50 per cent drop in the price of oil, a rapid change in the dollar and other exchange rates and another drop in commodity prices,” he said.
“Once you bring the rapid change in major benchmark prices and a change in the architecture of the global financial system together, you could end up with outcomes that are pretty painful, and certainly unknowable.”
He warned that the U.S. Federal Reserve’s first interest rate rise in almost a decade would also cause disruption, and that “the most transparent and telegraphed move in monetary history” was unlikely to prevent some dollar denominated debts from “blowing up” in emerging markets.
He said developing economies which had built up large debts were most at risk of capital flight. “The question is: is some of that debt going to blow up, and then is there a sovereign balance sheet behind it? Those countries are going to feel strained.”
