According to a recent report by Morgan Stanley "market liquidity across assets is in decline" and "low liquidity were the fundamental triggers of the 2008 crisis." Those bankruptcy practitioners that had first hand experience of the 2008-2010 turmoil, will recall the frustration of not being able to help clients workout of a distressed situation because of the lack of liquidity (e.g., alternatives). Often bankruptcy was the only alternative and even that option was less than optimal because the market for additional capital or options was broken. Liquidation was often the only option.
One example cited by Morgan Stanley relates to corporate bonds. According to their report: "Dealer holdings of corporate bonds have shrunk from 3% of the market to just 0.3% today. While this means that dealers themselves have less to liquidate, their capacity to move risk to a new buyer may be limited and require larger repricing of the asset class in times of stress." The repricing is likely to mean reduced value for corporate bonds and may result in other strategies for offloading such positions. One such strategy might be vulture buying of this asset class and potentially an "own to loan" strategy or a liquidation strategy for certain asset classes.
Morgan Stanley cites another example related to public debt. According to Morgan Stanley, in the recent past, central banks built large positions in bonds. "As central banks built these positions, liquidity in the affected assets was excellent. It's hard to imagine anything better for liquidity than the presence of a steady, deep, well-telegraphed bid. But these forces are now swinging in the other direction. The Fed's purchases have already begun to reverse, the ECB's are likely to over the next six months, and with close to half of its bond market already owned by the BoJ, it will eventually face a constraint."
Given that the U.S. economy is in the late stages of an extended recovery that is close to a record-setting duration, and given the near certainty that the economy operates like a pendulum, the open question is not "if" but "when" will the U.S. economy stumble, how bad will it get and what will it mean for bankruptcy and other workout professionals.
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