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Is Liquidity Always
A Good Thing?

by David Stanowski
10 February 2007


The investment community, and the financial press, seem to be nearly breathless in their pronouncements that the world is "awash in liquidity"! Their implication is that liquidity is always a good thing! However, liquidity can come from two sources: savings or credit. It is obvious that this liquidity did not come from savings, but from a concerted effort by central bankers to stop the financial meltdown caused by the stock market collapse of 2000-2003.

Their methodology was not to "print money", but rather to extend credit to nearly anyone who wanted it.
At the same time, many who had accumulated equity in their homes, chose to withdraw some of it with home-equity loans, which added to the outstanding household debt. As borrowing and spending increased, our national savings dropped even further, so that it is now negative, which means that the country as a whole is spending more than our total income, and financing this lifestyle with credit.

National Savings Rate


Real Estate- Equity Extraction

Most of the newly created credit ended up in the residential real estate market as mortgages were written for virtually anyone with a pulse, whether or not they really qualified for the loans. The other step was to allow "creative payment terms" that the applicants could handle for the first few months, but would put them in "debtor's hell" when the terms reset. This added debt has created an unprecedented lack of liquidity at the household level. American households no longer have the cash to meet their liabilities.

Household Cash minus Liabilities 

What assets households still have are becoming more and more illiquid, made up as such things as real estate, cars, boats, furniture and jewelery. Things that will eventually have to be sold to pay  bills, and service debt.

At the same time, the amount of liquid assets, and current income needed to service mortgages has accelerated upward.

Mortgage Obligations versus Income

There are only two ways that this household liquidity squeeze can resolve itself. People will either become very frugal, and live on far less than their debt service costs, for many years, which will allow them to reduce these huge debts. Or, a massive wave of bankruptcies will erase much of the debt for them. Which do you think is more likely? 



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