Journal of Economic Literature June 2011 [antikvár]

Illiquidity and Ali Its Friends Jean Tirolé* The recent crisis was characterized híj mas.sive illiquidity. This paper reviews vohat we know and don't know about illiquidity and all its friends: markétfreezes,fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistic, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in plaee. The paper then analyzes markét breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity, ancl analyzes how markét value accounting and capital adequacy should react to asset prices. It concludes with a topicai form of liquidity provision, monetary bailouts and recapitalizations, and analyzes optimál combinations thereof it stresses the needfor macro-prudential policies. (JEL E44, G01, G21, G28, G32, L51) 1. Introcluction The recent crisis, we all know, was characterized by massive illiquidity. Various markéts (money, corporate debt, securitization, collateralized debt obligations (CDOs), etc.) groiind to a halt. Investors ran on a variety of institutions, including Bear Stearns, Lehman Brothers, and Northern Rock, before authorities guaranteed a substantial *Toulouse School of Economics. An earlier version of this paper was prepared for the 8th BIS Annual Conference on "Financial Systems and Macroeconomic Resilience: Revisited" (Basel, June 2009). The author is grateful to Emmanuel Farhi, Bengt Holmström, and Jean-Charles Rochet for joint work and extensive discussions on the topics of this paper, and to Franklin Allén, Mathias Dewatripont, Roger Gordon, participants at the BIS conference and at meetings at the Banque de Francé, and three anonymous referees for very helpful comments. fraction of the financial system. Financial institutions and industrial companies scrambled for cash by selling assets at fire sale prices. Central banks injected unprecedented amounts of liquidity into the system. Much of the current thinking on regulatory reform focuses on how to avoid a repeat of this episode. Regulators strive to homogenize their measurement of liquidity and to improve their stress tests. The Financial Stability Forum1 (2009) calls for "a joint research program to measure funding and liquidity risk attached to maturity transformation, enabling the pricing of liquidity risk in the financial system" (Recommendation 3.2) and recommends that "the BIS and IMF 1 Now the Financial Stability Board in its revamped version.