The total value of corporate bonds held by dealers has fallen dramatically in the past decade
Britain suffered its first bank run in a century. Television pictures showed a long queue of depositors outside a branch of Northern Rock. Alistair Darling watched in dismay from Portugal, where he and his fellow European Union finance ministers were gathered. “They’re behaving perfectly rationally, you know,” Mervyn King, the governor of the Bank of England, said in the smarty-pants manner that economists are cherished for. Mr Darling was uncharmed.
The dynamics of capital-market runs are similar to those of bank runs. You see them in currency crises. Foreign-exchange reserves, say, are slim relative to the scale of local-currency assets held by flighty investors. Should enough of those investors sell out, others will soon follow. The result is a rout. There is a similar pattern with investment funds that promise speedy withdrawals but hold assets that cannot be sold quickly. Bad news prompts withdrawals. The speedy get paid.
The ease with which investors can trade bonds—the market’s liquidity—depends a lot, then, on the readiness of dealer banks to stockpile securities. Where there is heavy selling, dealers would ideally warehouse cheaper bonds for when people want to buy again. But since the financial crisis new rules have made it less cost-effective for banks to use capital for trading of any kind. The inventory of corporate bonds held by dealers has fallen sharply in the past decade .
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