And I would also say it’s clear that market depth is less, meaning the ability to transact in large quantities is much less in fixed income markets in some fixed income markets than it was before the crisis. There are a variety of factors that are driving that. One of them is smaller risk appetite by firms. They will proudly show you how much less risk they are taking. Another is this advancing technology and another is regulation. It is really hard to disentangle the effects of those three.
So the question is, and I don’t really know the answer, but the question is -- is are we at -- is that a bad equilibrium. You know we got safer core, safe financial markets, large financial institutions, much better capitalized and much less risky. But you have got less depth in bond markets and the issue that some of the asset managers may be, investors in mutual funds for example, may be over estimating the liquidity that they’ll really have in a stressed environment.
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I don’t know. It is not obvious to me that that is a worse equilibrium that we had without those innovations. In any case I don’t think those three forces that I mentioned technology, risk aversion and regulations. I don’t think it is obvious that those are going to change at all. We might at the margin tinker with them but those are things that are probably going to remain.
It is certainly true that market depth is less, and inventories are much less than they were before the crisis. It is also probably true that systematically the cost of supplying liquidity and the cost of holding those assets was underestimated, inappropriately so, before the crisis. So, some of that is good. And again, if you sit down, as I have, with many of the large firms some of them will tell you, “this isn’t you, this is us. We are looking at our risk in a completely different way than we did before the crisis. And this was our risk before the crisis and this is our risk now.”
So it is not obvious it is all because of regulation. I do think there are many other factors. The right question is this, is it a problem? It is certainly possible, it is intuitively likely, that with lower market depth there would be higher volatility for a quantum of news or a shock of some kind. I think that is right.
Again, the question is, is this a better equilibrium? That is something that requires some thought, it is something that we at the Fed are looking very carefully at right now as are many others around the world.