Why You Should Care about Liquidity

Liquidity basically is free cash or investments in assets that are readily convertible to ben_franklincash without impacting the value of the asset. Money in a money market account is a liquid asset.

A stock or a bond in a stable market is a liquid asset; in an unstable market, it’s not. In a crisis, you might get a small fraction of what you paid for it. In a stable market, gold might be considered a liquid asset; in a crisis, not at all. That’s the crux of the problem.

The economic crash of 2008 was caused by liquidity issues. Once investors had to write down the value of mortgage-backed securities — often to zero — they faced a challenge to replace those securities if they were being used as collateral for loans. Without the promised collateral, they have to repay the value of the loan plus interest immediately. If they don’t have the cash (liquidity) to do that, all hell breaks loose.

JPMorganChase thinks that’s going to happen in 2018. The trigger this time will be The Federal Reserve’s reversal of investments it used to stimulate the economy, which the Fed recently announced it was going to start doing.

OK, why does this matter to you?

A liquidity crisis can affect consumers who have any kind of variable rate debt, such as credit cards. We might expect:

  • Interest rates to increase
  • The size of the required monthly payment to increase
  • The amount of credit available to decrease
  • Those with mediocre repayment histories to have accounts cancelled

Consumers with equity credit lines on their homes or variable rate mortgages will get zapped.

Some employers, particularly small businesses will get hurt and be forced to layoff workers.

If you’re living paycheck-to-paycheck and have debt, you’re going to have greater difficulty meeting your bills.

OK, the warning is out there. If you have a cash crunch, you can’t count on having credit to bail you out. Here’s what you need to do:

  • Create or review a budget.
  • Find ways to cut your day-to-day expenses. Do you really need that latte? Is it time to buy an antenna and drop your cable TV service? A lot of people are doing that.(3)
  • Start throwing everything you can into a savings account (Federally insured). At some point, you may need that money in order to eat. (Yes, the rates now are poor. Barclays (where my LLBean card lives) offers a rate of 1.3% with no minimum deposit. These rates will increase.)(2)

Of course, on the positive side, if we have a nuclear war, you’ll be dead and you won’t have to worry about any of this.

Short of that, you need to build your liquidity. Now.

“Rather go to bed without dinner than to rise in debt.” — Benjamin Franklin


Sources:

  1. Joseph Ciolli, “JPMORGAN: Here’s what could cause the next financial crisis,” Business Insider, 4 October 2017. https://www.aol.com/article/finance/2017/10/04/jpmorgan-heres-what-could-cause-the-next-financial-crisis/23232687/?brand=finance&ncid=txtlnkusaolp00002412
  2. Bankrate, “Today’s Highest Savings and Money Market Rates,” http://www.bankrate.com/partners/sem/savings-accounts-mma-v3?gclid=EAIaIQobChMI2ruRkrvf1gIVAUCGCh2uBQ3AEAAYAyAAEgLS0fD_BwE&prods=&ttcid=best+interest+rates+on+savings+accounts%7cc%7ckwd-332312178%7cg%7c9003967&ef_id=WdTqvQAABNtPjA80%3a20171007213251%3as
  3.  Susan Cole, “Best Ways To Cut The Cord And Slash Your Cable Bill,” Forbes, 17 January 2016. https://www.forbes.com/sites/nextavenue/2016/01/17/best-ways-to-cut-the-cord-and-slash-your-cable-bill/#42a5db94ff97
Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s