Liquidity Crises A sudden and prolonged evaporation of both market and funding liquidity, with potentially serious consequences for the stability of the financial system and economy.

1. LIQUIDITY CRISES
BY
RONEL ELUL –
SENIOR ECONOMIST IN RESEARCH
DEPARTMENT OF PHILADEPHIA FED.
Presented by :
Mohd Khairulrizal bin Rosley
Zaki bin Aman

2. Contents
a) Introduction
b) Factors Financial Crises
c) Main Features That Occur Due To
The Liquidity Crisis
d) Government Intervention To Solve
Liquidity Crisis
e) Conclusion

3. INTRODUCTION

4. INTRODUCTION
Liquidity
Term used to describe how easy it is to
convert assets to cash.
Liquidity Crises
A sudden and prolonged evaporation
of both market and funding liquidity,
with potentially serious
consequences for the stability of the
financial system and economy.

5. • Long-Term Capital Management
(LTCM) was a very large hedge fund
($126 billion in assets) that nearly
collapsed in late 1998.
• The founder was a Salomon Brothers
trader, John Meriwether, and the
principal shareholders were Nobel
prize-winning economists Myron
Scholes and Robert Merton.
• These were all experts in investing in
derivatives to make above-average
returns and outperform the market
• U.S. and world financial markets
found themselves facing a possible
financial crisis, and the U.S. Fed
found itself during a difficult scenario.
• turning into clear that banks and
alternative financial establishments
would ultimately lose tens or perhaps
many billions of greenbacks from
their exposure to subprime mortgage
market loans.
• Bank loaning is closely tied to bank
capital or internet worth—specifically,
bank regulators need that loans not
exceed an exact multiple of capital.
Thus, the Fed moon-faced the danger
of a pointy contraction in credit and
bank loaning during a approach that
vulnerable a deep recession or worse.
Con't
LTCM Financial Market 2007

6. Factors of Financial Crises

7. Some money have very little impact outside
of the money sector
Some third generation model s of currency
crises explore however currency crises and
banking along will cause recession

8.  The risk related to debts and assets don’t
seem to be fitly aligned
 The couple between the bank short run
liabilities ( its deposit ) and its semipermanent
assets ( its loan ) is seen in concert of
explanations bank runs occur

9. Borrowing to finance investment
However may lose over all its
Conjointly creates a risk of bankruptcy
Imply that a firm fails to honor all its secure
payments to different
Companies, its going to unfold money
troubles from one firm to others

10.  Major goal of regulations is transparency,
creating institution money
things publically famous by requiring regular
reportage underneath standardize accounting
procedures
 Regulator failure to protect against excessive
risk taking within national economy.
 Fraud in mortgage funding as their manager
did not do their fiduciary duties

11. o Investment mistakes caused by lack of
information or the imperfections of human
reasoning
o Herd behavior causes cost to spiral up way
on top of truth worth of the assets, a crash
might become inevitable

12. Liquidity crisis might unfold from one
establishment to a different as one bank
withdraw spreads from some bank to
several other, or from one country to other.
Once the failure of specific establishment
threatens the steadiness of the many
different establishments is often know as
general risk

13. ANALYZING ISSUE

14. MAIN FEATURES THAT OCCUR
DUE TO THE LIQUIDITY CRISIS

15. FLIGHT TO QUALITY
• A Movement by investor to buy higher quality
security
• Occur when a deteriotion in politic stability or
in economic activity
• Bank preserve their liquidity and cut back on
lending
Brunnermier & Pederson Model (1998)
• Liquidity scarce – market participant prefer to
conserve it by investing in less risky assets

16. LIQUIDITY SPIRAL
• Liquidity problem spread to other market
• Price continue decline-breach
agreement and force selling will occur
• Financial constraint –
difficult to borrow
affect the value
Lasee H.P model ( 2008 )
Bank- as main player to improve funding

17. Cont
• Recapitalise-raising
new capital
diluting old equity
possibly reduce face value of old debt
broadening bank guarantee
opening the Feds discount window
ensure the Commercial Paper market function

18. SUBPRIME MORTAGE DEFAULT
• Failure financial instrument have fueled
financial market turmoil.
• Borrower default on his loan – lender fail to
provide liquidity to meet operational cost or
return to fund providers
Diamond-Dybvig model (1983)
Financial intermediation- accept assets that
inherently illiquid and offer liability which
are much liquidity- make bank vulnerable to
a bank run

19. Cont
• Emphasizing the role played by demand
deposit contract-provide
liquidity , better sharing among
people , potential undesirable equilibrium
depositors panic and withdraw their deposit
• Liquidated assets sold at loss- bank also will
liquadated all the asset even if not all
depositors withdraw

20. LIQUIDTY HOARDING
• Liquidity crisis continue worsen
• Bank take carefully action-reduce
provision of liquidity in market
hoarding the liquidity to prepare second wave
Markus K. B and Lasse model ( 2008 )
Trading require capital
Trader buy security and use as collateral to borrow
against but cannot borrow at the entire price

21. Cont
• Margin/haircut – difference between security
price and collateral value – so balance must be
finance with the trader own money
• Funding liquidity unavailable- trader reluctant
to take position especially in high margin
securities
• low future liquidity increase the risk of
financing a trade, thus increasing margin

22. THE FAILURE OF FINANCIAL INSTITUTIONS
PROVIDE THE LIQUIDITY FUND
• Investor need fund to operate and raise fund
from the financial institutional
• Fail provide fund- price declining because
investor not enough fund and the seller will
lower the price to induce the investor to buy
with limited source.
• Scarce liquidity – suffer losses in other
activities or not provided efficiency
• Lender unwilling to offer sufficient fund

23. Cont
Federal Reserve Board ( 1998 )
• Tightened lending standard and terms –
to avoid own losses or exposure
• Deterioration in their parent bank capital
position

24. SUGGESTION /
RECOMENDATION

25. GOVERNMENT INTERVENTION TO SOLVE
LIQUIDITY CRISIS
4.1 Provide liquidity in time of crisis
 Taxing consumer
 Printing money
Role for Policy
 Pre-Emptive or Ex-Ante Policy Imposition of minimum equity
 Exposit Policy Intervention Some experts suggest that the
Central Bank should provide downside insurance in the event
of a liquidity crisis.

26. • The ambiguous weapon system nature of liquidity provision by central
banks
Given the potential limitations of alternative tools, a good financial
institution framework to provide liquidity to the national economy could be
a necessary part of arrangements to handle liquidity crises.
• The need to develop principles for the availability of financial
institution liquidity
• By now, there's a fairly well developed set of principles for the way to
handle the failure of individual establishments and therefore the
corresponding supporting role of emergency (funding) liquidity.

27. The desirability of fitting place (variable) speed limits
This follows from the chance that rising the monetary
infrastructure, like PSS, and introducing buffers, like within
the sort of minimum capital and liquidity ratios, might fail to
act as a brake within the growth section

28. • The role of payment and settlement systems (PSS)
The role of PSS is vital as a result of, if badly
designed, they will exacerbate liquidity crises once
they go on.

29. • The role of (retail) deposit insurance schemes
Of specific concern is that the chance of runs on
otherwise solvent establishments that would cause
them to fail.

30. • The growing reliance on funding liquidity in a very market-based
national economy
Many observers expected the event of markets to scale back the reliance on
funding liquidity, within the sense of dependence on external funding.
• The individual and systematic parts of liquidity crises
• a) The First Common -the dynamics of liquidity crises could be a
reciprocally reinforcing feedback between market liquidity, funding
liquidity and counterparty risk – or credit risk .
• b) The second common feature is that liquidity crises don't seem to be like
meteor strikes; rather they are the endogenous results of the build-up in
risk-taking and associated overextension in balance-sheets over a
protracted amount – what could be termed the build-up of monetary
imbalances

31. • The need to enhance buffers
Continuing with the analogy with policies towards
road safety, this effectively suggests that put in place
higher buffers, like automotive bumpers and guard-rails

32. • The global monetary crisis has beat home the
importance of the evaporation of liquidity within the
dynamics of monetary distress.
• Policies aimed toward preventing associate degree
addressing such crises hare regained an urgency that
they had lost for a few time (Goodhart (2007)).
• A lot of reflection and soul looking out is beneath
means in each policy and personal circles.