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 mobilise 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.

From Policy to Regime: the changing posture of the ECB between liquidity and collateral through the lens of Monetary Regime

“…A repo transaction is a reversible secured loan, in which a financial agent sells an asset to another agent at one price "and commits to repurchase the same or another part of the same asset from the second party at a different price at a future date" (ICMA, 2014). In addition to being used for monetary policy purposes, repos have become more and more popular in private markets since the 1990s primarily due to "technical innovations, Basel regulation and International Capital Market Association (ICMA) harmonization" (Krarup, 2019).…”

“…This excess liquidity emerged organically as the Eurosystem began buying government bonds -although they were not the only instruments -on considerations other than fiscal ones. The motivation of these acquisitions is inherently related to the role of collateral of government bonds in repurchase agreements (repos) (Krarup, 2019). Therefore, if the Maastricht Treaty argued the importance of monetary independence and the prohibition of government bond purchases, the Euro crisis revealed that this independence is obsolete and that the Eurosystem's posture is influenced by the yield of government bonds.…”

Money and the ‘Level Playing Field’: The Epistemic Problem of European Financial Market Integration

“…This pushed the ECB to buy corporate bonds and other assets hitherto considered too insecure and volatile for use as collateral (Klooster and Fontan 2019). Indeed, one of the things that broke down with the financial crisis and the ensuing European debt crisis was the pre-2008 relationship between collateral and credit (money), specifically how it was organised in repo lending, government borrowing and collateralisation mechanisms (Mehrling et al 2015, Gabor 2016, Krarup 2019a, Sissoko 2019. This situation has revealed what Mehrling (2013) This new role has changed the image of monetary policy.…”

“…The ideas-practice conception tends to presuppose an opposition between a sphere of highly consistent doctrinal thought in (academic) economic theory and a sphere of pragmatic inconsistency and the politics of strategic interests. By contrast, taking the tensions, contradictions, paradoxes and conceptual insecurities of neoliberal economic thinking seriously suggests that 'epistemic problems' (Krarup 2019a) may account for some of the variation and doctrinal inconsistencies encountered in market formation and integration processes, which have otherwise been ascribed to contingencies of practice. Instead of seeing 'ideational factors' as more or less coherent theoretical doctrines competing for political influencesuch as German ordoliberalism (Bonefeld 2012), French dirigisme (Clift 2012) or Chicago School imperialism (Bartalevich 2016) -we could ask how the problems characteristic of certain types of economic thought are deployed across academic and political spheres.…”

“…What is the alternative to the seemingly irreconcilable opposition between consistent 'ideas' and muddy social practice? Following Krarup (2019bKrarup ( , 2019a, my suggestion here is that a domain of thought may be defined instead by the central problems (as opposed to tenets) with which it is concerned -and, consequently, by the characteristic pattern of 'theoretical' tensions, contradictions, paradoxes and conceptual insecurities that it entails across 'academic' and 'political' spheres. In other words, to borrow a notion from Foucault (2002, p. 129), an epistemic problem is the characteristic 'principle of differentiation' of a mode of thought that distinguishes it from other modes of thought.…”