May 10, 2010
Translating from the Greek
Posted by Erik Gerding

At the Faculty Lounge, Kim Krawiec continues to do a major public service with her series of posts on the Greek crisis (including visits by sovereign debt experts Lee Bucheit, Mitu Gulati, and Anna Gelpern).  Bucheit and Gulati just posted on ssrn an extremely timely analysis of how Greek debt would be restructured based on the terms of the Greek sovereign debt contracts.

Meanwhile, Anna Gelpern (who drops by this site from time to time) has two posts today over at the Roubini site.  She labels the EU/IMF emergency funds for Greece as "illiquency support" because the crisis mixes the worst of both a liquidity crisis and a solvency crisis.

Which leads to some interesting questions for the global financial crisis as a whole.  Ideally, we would be able to categorize a financial crisis (whether for an entire market or just a subset of financial institutions) as either a liquidity crisis or a solvency crisis.  The distinction would mean not only different crisis responses -- for example, short term emergency loans for a liquidity crisis versus use of a bankruptcy or conservatorship regime for a solvency crisis -- but also a different focus on regulation for crisis prevention.  If we are worried about liquidity crises, we might focus on liquidity requirements (e.g. is a financial institution holding enough liquid assets to cover the threat of "runs") and making sure we have a lender or liquidity provider of last resort, etc.  For solvency crises, the attention might shift more to capital requirements (e.g. is a financial institution's balance sheet robust enough to sustain likely losses).

The problem, as Professor Gelpern notes with her newly minted term "illiquency", is that it isn't always so easy to make the distinction between the two types of crisis.  What looks like one type of crisis can shape shift into another.  Gelpern has written a lot on the various modes of crisis response with deep historical and international perspectives.  Crisis responses often have a major degree of flexibility - which makes sense in fluid situations when crises can't be neatly divided along liquidity/solvency or other lines.  But breaking eggs to make omelets means we have problems when we move back to crisis prevention mode and try to unscramble the eggs.

Addendum:  It turns out "illiquency" is not such a new term.  In fact, Anna first used the term in a post on this site in October 2008 in the midst of the bailouts here in the U.S.  Anna continued to use the term to discuss the difficulty separating insolvency from illiquidity in posts at Credit Slips on the TARP.

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