Why No Liquidity Futures?
A slight digression from the topic here, but the following is from Bill Gross of PIMCO (writing in the Washington Post and echoing a point I’ve heard elsewhere):
While the newborn derivatives may hedge individual, institutional and sector risk, they cannot hedge liquidity risk.That’s true. But why? Why aren’t there derivatives to hedge liquidity risk? Surely it’s possible to create a futures contract on a bid-ask spread (or maybe separate futures on the bid and the ask). Market-makers could even use the contracts to hedge against excessive liquidity. The contracts would require some kind of rule for dealing with situations when there is no observed bid, as is apparently the case with many mortgage-backed securities today, but presumably a rule can be worked out.
posted by knzn at 8/24/2007 04:39:00 PM
4 Comments:
Neither necessary nor hedgeable is the short version.
Not that that has stopped other contracts and OTCs from being invented, but you can see the standard error made by Bookstader et al. -- there is no such thing as Too Much Liquidity, only Too Little is an issue.
If this ends up being extended, you might get a market out of it--but it would be the same players who tend to get INTO liquidity crunches. As Tavakoli observed several years ago in this book, an exposure to Korean liabilities that is guaranteed by the Korean government is, realistically, worthless--even if someone is willing to pay for it.
Similarly, the guarantee of an investment bank in a Liquidity Crunch isn't exactly a high-value asset. Would take a concerted effort by an old-line insurance company or similar to make a market in them.
From what I hear, the futures markets have been quite liquid through most of the current crisis. The guarantee of an investment bank, if it’s backed up by a clearinghouse and appropriate margin requirements, could be valuable even in a liquidity crunch. The trick would be setting the margin requirements, I suppose. And it seems to me it could be hedged using something like the TED spread, meaning that somebody has to accept the risk that you have a liquidity crunch without a repricing of credit, which is one of those small risks that presumably some hedge fund would be willing to accept.
Of course there are liquidity futures.. and they are the most actively traded of instruments...
They're called US Treasuries.. and in conjunction with the Eurodollar futures contracts they are a liquidity instrument..
Simple.. you want to "warehouse" liquidity for some future time?
Buy say an 2 year Treasury.. sell a strip of Euro's... (or pay fixed on a swap but the correct way and obviously the most used is the massive Eurodollar futures contracts)
If any day in the future you need funds... you simple sell out a portion of the Two Year you own.. this is called a repurchase agreement..
But in its essence a repo is a secured borrowing..
No matter who you are..no matter how many ABCP's on your balance sheet.. no one cares.. you can borrow money against a US Treasury without regard to who you are or you other circumstances.
In fact when the trouble stats brewing as now.. you get paid for owning the US Treasuries.. as you can borrow at the repo rate .. which is now trading nearly 70 basis points below the LIBOR rate...
To professionals... the amazing thing is that banks which used to do this all the time forgot that liquidity is the name of the game...
But why would you want to give up a few basis points of yield by owning US Treasuries....
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