From 2003 to 2007, we went through a period where the balance sheets of financial entities went through a systemic downgrade.? They became:

• More leveraged
• Less transparent via derivatives
• More reliant of floating rate finance
• Reliant on debt structures with shorter maturities
• More sensitive to calls on cash via ratings-sensitive collateral agreements

That is what has set us up for the problems that we have today.? In the bond markets, those conditions have led to the failures of many large market makers, straining the remaining system.? The remaining market makers in bonds are offering little liquidity amid the panic.? It doesn’t matter what sub-segment of the bond market I point at, every part faces a lack of risk-bearing capacity as parties hoard cash.

Part of this is the fault of the Treasury and Fed, as they proffered their TARP and pulled it back.? The greater the uncertainty from large parties, the more that small parties run and hide.

Away from that, many parties with capital have decided (seemingly) as a group to seek safety all at once, leading to a general malaise in all things risky.? Part of that could be related to the original TARP, as many parties decided to wait on selling until the TARP came along.? With no TARP (as originally conceived), those inclined to sell made offers, and the markets balked.

What can I say? Compared to 2002, there are fewer entities willing to bear credit risk during the crisis, even for short amounts of time.? This allows for arbitrage situations that don’t immediately get resolved, because no one has the balance sheet necessary to do it.

Eventually we will get to a point where those with unencumbered cash will make an effort to close those arbitrage gaps, and lend to worthy businesses at exorbitant rates, but it may take some time.? Until then, the market will flounder in the volatile way that it does.