Fish Don't Know They Are Wet

Federal Reserve Governor Kevin Warsh delivered a speech entitled "Financial Market Turmoil and the Federal Reserve:  The Plot Thickens" to the New York University School of Law Global Economic Policy Forum today.

Warsh identifies excessive liquidity as the root cause of our current financial problems. He says,

"Some believe the story of the current market turmoil began in August, and will end when the housing market stabilizes. But, in my view, the narrative actually began in a seemingly more benign time with underpinnings more fundamental than the value of the housing stock. Financial institutions and other market participants grew increasingly dependent on the extraordinary liquidity around them. When liquidity faltered, the weaknesses of the existing architecture abruptly revealed itself."

"A metaphor, perhaps, is instructive: Fish don't know they are wet. And they don't learn unless their memories are long or the water is gone."

My take:  With all due respect, excessive liquidity is only one factor in a deepening disaster.  Warsh concludes this speech with a call to make liquidity a key consideration in the proposed reorganization of the financial regulatory structure.  I'm just not sure what that means, but here's what he says: 

"A new financial architecture, born of the forces of creative destruction, is early in the process of construction with the aid of the Federal Reserve and other public authorities. But for the new paradigmatic architecture to be enduring, market-supplied liquidity must come to predominate."

My take again:  ?????

(ag) April 14, 2008, in Economy