The collateral liquidity problem in contemporary finance and the resurrection of quantity theory

Abstract

Since the 2008 crisis, the liquidity of collateral has become a serious concern for financial market institutions and regulators due to its increased importance in risk and cash flow management. Surprisingly, market participants mobilize old-fashioned economic theory, such as Irving Fisher’s quantity theory of money in their discussions of how to deal with the new problems of collateral liquidity. Today, ‘collateral is the new cash’, as one sector report claims, marking a shift from a quantity theory of money to one of collateral. Liquidity, I argue, poses not only practical problems to market participants and regulators, but also epistemic ones. Accordingly, practitioners not only produce practical but also theoretical responses to it, mobilizing classical economic theory in so doing. The problem of liquidity is shown to relate closely to a problem of ‘sovereignty’ in the narrow sense of guaranteeing the safe value of collateral. Contrary to established conceptions, sovereignty in this sense is not limited to states, but can also occur with monopolistic agents in the market such as global custodians. Thus, following the recent decade of crisis, general epistemic problems of liquidity and sovereignty in contemporary finance become visible through the practical problems and solutions in relation to collateral – specifically in the practical problems of buttressing liquidity in its double nature of collateral velocity and quality or safety.