The Downside of an Illiquid Market

Article

The Downside of an Illiquid Market

Abstract

The euphoria in the run-up to the financial crisis artificially increased the demand for all asset classes, including agency mortgage-backed securities (MBS). The result was an asset price bubble as well as a liquidity bubble that has since burst. Despite the drop, MBS liquidity remains healthy, with occasional volatility caused by greater regulation and more concentrated ownership of MBS.

We discuss the causes and implications of reduced liquidity and our conclusion that current liquidity levels are here to stay. While current liquidity levels are no cause for immediate alarm, a substantial deterioration could have serious negative consequences for lenders and borrowers.

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