Nouriel Roubini was among the few economists to foresee the 2008 financial crisis. Now he’s worried there will be another “bust and collapse”. The seeds for the next crisis have been sown by the authorities’ response to the last one.
While economies are swimming in liquidity, increasingly overheated markets, especially bonds, have too little of it. If markets are illiquid, buyers can’t find sellers easily and vice versa, which implies big, sudden price movements if investors all rush in the same direction at once.
In stockmarkets, high-frequency traders (HFTs), who use computers to carry out short-term trades, account for a growing share of transactions. This creates “herding behaviour”. They are most active at the beginning and end of the trading day, leaving fewer transactions, and less liquidity, in the middle. In bond markets, the dearth of liquidity is a result of new regulations.
These have made it more expensive for banks to hold bonds, making them far more reluctant to act as buyers and sellers – “market makers” – and thus grease the market’s wheels. Without banks acting “as a stabiliser”, a selling stampede could cause violent price falls and widespread losses. Market illiquidity “is a time bomb”.