ABSTRACT
This chapter argues that the scale and scope of the phenomenon of shadow banking, and its constitutive relationship with the ‘official’ banking system, is leading scholars and regulators to rethink some of the major concepts of finance, such as money, collateral, risk and arbitrage. This chapter suggests that a similar analytical effort is needed when drawing lessons about the role of ‘liquidity’ in light of the crisis and the developments in the shadow banking industry. Today, major paradigms of financial economics and financial regulation tend to place the ultimate source of ‘liquidity’ in the realm of the financial market. Such a vision, for instance, has been the foundation of the Basle accord approach to banking regulation, which had assumed perfect and available market liquidity. The crisis of 2007–09, sparked off by an international liquidity crunch and having been transformed into a crisis of the ‘shadow banking’ industry, has revealed the limitations of such approaches. The aim of this chapter is to offer a conceptualisation of liquidity not as an exclusive function of price, but as a complex legal mechanism underpinning the economic cycle. Following the insights of the early theorisations of liquidity developed in the 1930s–1940s, the author suggests that any investigation of liquidity in the context of an economic system, is ‘a study of the mechanisms which make particular forms of wealth acceptable’. Revising the insights of the early socio-legal studies of liquidity to the phenomenon of shadow banking, the chapter shows that the financial crisis is best understood as an outcome of the conflict between market liquidity mechanisms, on the one hand, and financial innovation mechanisms through shadow banking, on the other.
