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Three Facets of Liquidity Illusion: Financial Innovation and the Credit Crunch

GPS, Vol. 4 No. 3, (2008)

This article identifies the phenomenon of liquidity illusion as
the key element that has disguised the systemic fragilities
which have precipitated the global credit crunch. At the core
of phenomenon of liquidity illusion lies the spiral of private
financial innovation and risk-trading processes underpinning
it. The paper identifies three intertwined levels where
liquidity illusions have led to systemic implosions:
macroeconomic, market-centred, and international. Today’s
facets of liquidity illusion stem, just as Keynes observed some
seventy years ago, from the trade-off between individual
choices and perceptions of financial players, and aggregate
outcomes of these actions in a wider context. The article
analyses this trade-off in the context of the continuing global
credit crisis.

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