Credit Markets Aren't Liquid Enough for a Mass Selloff

Jon Jacobs wants "an unrestrained, cathartic selloff" in the credit markets. He makes a good point: that banks are holding on to the assets they've written down in the hope, basically, that they're smarter than the markets.

The only way bank executives can be proven right in refusing to dump their bad bets is if they know more than the market. And you don't have to believe in efficient markets to believe the market is more likely right than some of the players who are caught in what now looks like a losing trade. Remember: Even if the market is wrong, it could be wrong in the opposite direction - high-risk loans and structures could ultimately turn out to be worth less than the market is now paying.

Jacobs quots Meredith Whitney saying that "what we need to see is a true purging to get the system back to a state of restored liquidity". But this doesn't make a lot of sense to me. Just look at what's happened to the CDS market as a small-to-middling hedge fund starts liquidiating its holdings, or what happened to wheat prices in the wake of one weird trade. Markets aren't liquid enough to cope with an unrestrained selloff at the best of times; right now, they'd just seize up altogether and go no-bid.

All the banks can do is mark down their holdings; there simply aren't enough potential bidders out there at any price to cope with an actual sale - certainly not if, as in the auction-rate market, all the banks seem to come to exactly the same decision at exactly the same time.

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