Karl Denninger at The Market Ticker explains the reason we have illiquid assets. Even a caveman can understand it.
Very simply, illiquid assets are created when a buyer and seller can't come to an agreement on price. The gap between the bid and ask price is just too large.
What's creating this gap that can't be bridged? Answer this and you can have a chance at finding the solution.
Let's say that a bank has a mortgage backed security that is worth 50 cents on the dollar. As long as the bank thinks that the government might come in and eventually bail them out at 80 or 90 cents on the dollar, they will never agree to sell at 50 cents.
With the government constantly changing the rules of the game, an investor has to price in the possibility that the government will change the game to their detriment after they make their investment. So instead of offering 50 cents, they might feel they need a safety cushion and only offer 30 cents on the dollar.
If both parties weren't calculating the possibilities of bailouts or rule changes, both parties would be able to find a price that worked for them and the markets would magically unfreeze. People would be able to make rational decisions and get moving again.
Watch this video as Karl Denninger explains it.
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