Tags: Treasury | liquidity | market | crisis

Dimon's Right: Regulators Barred the Door After the Horse Escaped

By    |   Wednesday, 15 April 2015 08:19 AM

What happens when investors want to sell and no one's willing to buy? The market crashes.

This has always been true, but new regulations increase the risks that no buyers will be around, according to JPMorgan CEO Jamie Dimon. In recent comments, Dimon highlighted this problem in the bond market.

"Then on one day, Oct. 15, 2014, Treasury securities moved 40 basis points, statistically 7 to 8 standard deviations — an unprecedented move — an event that is supposed to happen only once in every 3 billion years or so."

The price move in Treasurys was caused by a lack of liquidity in the market. Liquidity simply means that buyers and sellers are able to find each other in the market. This applies to bonds, stocks or any other market.

Dimon's concern is that banks will have limited liquidity available when market activity spikes. In the past, banks would step in and smooth the market action in Treasurys. New regulations put in place to prevent a repeat of the 2008 market crisis prevent banks from doing that next time.

In the stock market, market makers historically stepped in to provide liquidity. Regulations implemented during the past 15 years prevent that from happening in the future.

Market crashes all have different long-term causes, but the initial moment of panic always occurs when liquidity disappears. Regulators have already guaranteed a liquidity crisis will develop at some point in the bond and stock markets. They are now focused on options and futures markets where many exchange-traded funds (ETFs) rely on liquidity to avoid crashes. Soon, no market will offer guaranteed liquidity in a crisis.

Once again, regulators have done their best to close the barn door after the horse got it. By ensuring there will never be a repeat of 2008 they have laid the groundwork for the next crisis. We will only know when that crisis hits in hindsight, but we know that crisis will be worse than it should have been because of ill-conceived regulations.

To avoid the dangers associated with liquidity crises, investors need to limit leverage. This idea applies to leveraged ETFs as well as margin loans. Limited leverage could allow you to survive the short-term losses regulators cause in the future.

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What happens when investors want to sell and no one's willing to buy? The market crashes.
Treasury, liquidity, market, crisis
Wednesday, 15 April 2015 08:19 AM
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