Insurance companies and pension funds, on the other hand, have limited capacity for credit risk, but more for market and liquidity risks.

For, even as the central banking authority administered the price of liquidity, the price of risk was left to the tender mercies of the market.

Liquidity risk is best hedged through diversification across time.

Critics might cite the moral hazard risk generated by liquidity support.

First, central banks suspended the rules of the free market in liquidity squeezes.

Credit risk in the mortgage market is being assumed by the government, and market risk by the Fed.

All these non bank institutions are now potentially at risk of a liquidity run.

The breakdown was fundamentally a liquidity crisis, and liquidity was easily restored in several ways the New York banks issued their own liquidity through a clearing house one massively powerful financial institution, J.P. Morgan, bought up collapsing shares, and thus reversed a market panic and a scramble for liquidity and European central banks supplied gold to the American market.

Restoring financial market confidence has had to rely on liquidity injections by major central banks.

The proposal would also have required that money market funds hold back a fraction of some redemptions, thereby making investors take some risk that funds might not have complete transactional liquidity if their investments weakened.

But, while banks with short term funding and many branches originating loans have a deep capacity for holding credit risks, they have a limited capacity for holding market risks, and little capacity for holding liquidity risk.

With so much internal liquidity, these businesses are not sensitive to reductions in market interest rates.

The fund's objectives, typically, are those of (a) maximizing risk adjusted returns, (b) security of capital and (c) liquidity, and their respective attitudes to risk.

So, central banks must set the price of liquidity in the market day in and day out.

But this is really a theory about risk management for certain kinds of products, not liquidity per se .

Finally, liquidity risk should be properly assessed in risk management models, and both banks and other financial institutions should better price and manage such risk most financial crises are triggered by maturity mismatches.

And a philosophy that asserts that financial innovation, market completion, and increased market liquidity are always and axiomatically beneficial provides a clear basis for regulatory decentralization.

The emerging market economies are at risk as a result.

Traditionally, sovereign risk has been concentrated in emerging market economies.

At the time, the United States did not have a central bank to inject liquidity back into the market.

Furthermore, ample worldwide liquidity and the rise of other commodity prices induced market speculators to buy into oil futures.

The ECB s task is to provide liquidity to banks, while the EFSF and ESM are designed to absorb solvency risk.

Like banks, all these financial institutions are subject to liquidity or rollover risk the risk of going belly up if their creditors do not rollover their short term credit lines.

Today, Spain and Italy are at risk of losing market access.

Surprisingly, the bond market still seems almost oblivious to this risk.

Non EurepGAP compliant suppliers therefore even risk losing domestic market shares.

Sharp rises in sovereign, corporate, and interbank liquidity spreads will increase the cost of capital, and increases in risk aversion, volatility, and sovereign risk will undermine business, investor, and consumer confidence further.

Instead, it relies on value at risk (VaR) measures that link risk to standard notions of short term market volatility.

In a turbulent world of market volatility, however, they risk being overwhelmed.

Moreover, taxation would increase costs (passed on to borrowers) and reduce the volume of transactions, thereby fueling market volatility amid decreasing liquidity.

The term awash with liquidity was also used often in 1999 and 2000, just before the major peak in the stock market.

Call it information liquidity, akin to financial liquidity.

Money market funds perverse incentives to take on excessive risk remain largely intact.

Critics might cite the moral hazard risk generated by liquidity support. But a well designed framework that offers swap lines only to well qualified emerging economies and only temporarily would diminish this risk substantially.

The result is financial risk taking that exceeds what would be warranted strictly by underlying fundamentals a phenomenon that has been turbocharged by the short term nature of incentive structures and the lucrative market opportunities afforded until now by central banks assurance of generous liquidity conditions.

On the contrary, the Peoples Bank of China (PBoC) and other relevant authorities should consider capital controls, market suspensions, and emergency liquidity provision.

In a push to reduce the cost of borrowing, the Fed purchased long term assets in the market, injecting liquidity into the financial system.

Even with their liquidity injections, the fallout from the financial crisis has eliminated the risk of a wage price spiral that might otherwise have arisen.

The key question, however, remains whether China is defying market forces at its own risk.

This brings me to my third point we must reconceptualize the meaning of market risk.

Because banks would need to accept higher risk, a secondary market for mortgages is necessary.

The ECB s treatment of all such debt as equally powerful sources of back up liquidity now trumps any analysis of differences in long term sovereign risk.

But by stubbornly arguing that that these countries are facing a liquidity crisis, rather than a solvency problem, euro officials are putting entire system at risk.

The problem is that the Fed s liquidity injections are not creating credit for the real economy, but rather boosting leverage and risk taking in financial markets.

European governments debt may all be denominated in euro, but German and Italian debt are hardly the same thing, so the government euro bond market lacks the depth and liquidity of the US Treasury Bill market.