The Economist on Credit Derivatives and Market Liquidity
In its special report, Credit derivatives: At the risky end of finance (April 19, 2007) , The Economist closely examines both the benefits and potential risks of credit derivatives. The pros of credit derivatives include the possibility that they make investing and trading in the bond markets more palatible. The cons are that they might be a ticking financial time bomb -- a "financial weapon of mass destruction" in Warren Buffett's phraseology -- that are vulnerable to shifting market conditions (e.g., a major increase in interest rates).
In this week's issue, Liquidity: Deal or no deal -- A new measure of market health (April 26, 2007), The Economist highlights how the Bank of England is trying to clear up the muddle about how to measure market liquidity. The Bank of England's measures (they have three) of liquidity is based on the "ease of buying and selling financial assets." According to its measures, the markets are flush with liquidity. Why? The article offers many explanations (hedge funds, financial innovations -- like credit derivatives, etc.), but it also points out that this surge of liquidity is a fickle thing. I.e., there will be more liquidity so long as investors are confident; when confidence wanes, liquidity probably will drop as well.