What exactly is a liquidity crisis?

Harvard University Professor Robert Kaplan and KLA Piper Senior Policy Advisor Bart Chilton discuss liquidity crises and the economy this morning on Bloomberg Television’s “Bloomberg Surveillance” with Tom Keene, Adam Johnson and Scarlet Fu.

Bart Chilton

Bart Chilton: The Next Liquidity Crisis: What Are the Signals?

Kaplan on what is a liquidity crisis:

“Basically what happens in a liquidity crisis, it is tougher to find a bid, people pull back they go to cash they go to risk-free assets. It tends to feed on itself and if it gets out of control, which is does sometimes, it goes to an extreme.”

Bart Chilton on liquidity crisis:

“I think the system is better. It doesn’t have to be overnight that people lose confidence, it could be in a heartbeat. Remember the flash crash from May 6, 2010 when the Dow dropped 1,000 points before it recovered and when it got down there wasn’t enough liquidity there and that’s why when we talk about these high frequency traders, they a good and they are bad. The markets would never have gone down so far without them, but they were resilient and they did go back up. They actually saved it at the end.”

Kaplan on the signals for the next crisis:

“Credit spreads. You look at whether credit spreads for governments and companies how much they widen out and how fast. And my worry is, though regulation we have more capital in the financial systems, that is good. We are dealing with interconnectedness to some extent. One of the outcomes of this is we are pulling capital out of making two-way markets in bonds, both corporate and governments and other mortgage related bonds. In the next downturn credit crunch, the street won’t play the rule people are used to. We don’t see it now, because there is so much liquidity in the system.”

Bart Chilton on where the CFTC was in 2008:

“We got the job done, after the fact, unfortunately. And I was at the CFTC. I started in 2007. I was the only regulator who was there before, during and after. The problem was regulators were asleep at the wheel. All of the regulators.”

On whether regulators can avoid the next liquidity crisis:

Kaplan: “The danger for regulators is they are often fighting the last war. They are trying to deal with Congress and answer questions and normally questions about what happened before. And we are actually maybe going through that right now. Instead of trying to anticipate what could happen, it’s tougher to talk to Congress and other supervisory bodies about what could happen next, but that is the conversation they need to be having.”


Bart Chilton: “You are right now. There were two culprits. There were asleep at the wheel regulators, even though there were some who were charging trying to get it done but the second culprit were some of the large financial institutions who took advantage of the regulators being asleep at the wheel and operated in the dark with no transparency whatsoever, became overleveraged and led to the crash. So regulators and the captains of Wall Street.”

Kaplan on whether the Fed Reserve being to blame:

“When you talk off the record, and it has to be off the record with some of the regulators at the fed, they are worried about getting hauled before congress and having to answer questions about the health of the banks. We are so hyper-focused. I think too focused now. The banks have plenty of capital. If they make a mistake like BofA just did and others they can manage it. My concern now is the impact on the markets and the ability of getting a small business loan, the ability to make two-way markets in the credit crunch. And I think we are creating the seeds to the next problem.”