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Liquidity and Recession



What has caused the economic difficulties facing many of the world’s top superpowers? The blame has been shifted to many parties – bankers, politicians, consumers and investors. However, we can comfortably name one word that basically brought the economies of the world to a grinding halt: liquidity.

By definition, liquidity is the ability for a company to be able to pay for goods and services with its cash on hand. For years, liquidity was never an issue. Credit markets flowed irresponsibly; any individual or company in need of liquidity simply had to make a request to a financial institution. The problem was that the market was too liquid. Cash was too readily available for individuals as well as businesses to borrow. Loans were extended to those who did not have the proper means to repay them. In fact, as debts became due, these non-creditworthy individuals and businesses took out more credit lines in order to repay their already established credit lines. It was similar to a “house of cards” where one bad move topples the entire structure.

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When huge financial institutions such as Lehman Brothers and AIG requested billions of dollars in emergency funds to help save them from collapse, it was a clear sign that this would be no ordinary recession. What was the biggest nightmare to multinational corporations eventually became the harsh reality for millions of households across the country. Investors, hungry for aggressive returns, encouraged lenders to write aggressive mortgage loans to consumers. Consumers in the United States, lacking proper financial education, agreed to the aggressive terms. When the short-term loans with fixed interest rates matured, there was no way to repay their mortgages without taking more credit. With the impending collapse of Lehman Brothers, the lending of money came to a grinding halt. It was not possible to obtain further financing. Every financial institution was highly reluctant to lend out the money that they had; thus causing an unprecedented crisis. Our market was no longer liquid. The global financial markets now faced a legitimate liquidity crisis.

Over the last few years, as the market has worked to recover from these devastating events, it has shown more than ever that simply having credit is not sufficient enough for a country, a company or a household to operate on. Being liquid – the ability to tap assets for cash at a moment’s notice – is of paramount importance. Financial statistics have shown for years that countries like the United States have a negative savings rate, meaning that consumers are spending much more than they bring into their households. With little or no savings, this means that in a catastrophic event a consumer must rely solely on credit.

Real estate markets around the world have experienced the effects of the lack of liquidity. Markets in various cities across the United States are seeing a flood of home foreclosures. This flood of housing inventory has driven home prices to record lows. With lenders afraid to write loans to consumers, the lending guidelines have become so stringent, that even the most qualified borrowers of the past are being denied mortgage loans. The absence of money to lend coupled with a vast quantity of homes to purchase have brought the real estate industry to a slow crawl. With so many industries that rely on the sale of real estate, e.g. construction, services and retail, etc., liquidity has been one of the main focus points to resolve the world’s financial crisis.



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