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资不抵债 vs 流动性不足
INSOLVENCY VERSUS ILLIQUIDITY

The distinction between insolvency and illiquidity is one of those lessons that both economists and financial market participants probably learned too well. The crisis made us all rethink it.

In principle, the difference is stark. A firm is insolvent when the value of its liabilities exceeds the value of its assets, making its net worth negative. Its next stop is probably bankruptcy court. A firm is illiquid when it is short on cash, even if its balance sheet displays a healthy net worth. In such cases, the firm needs short-term credit, not euthanasia. Insolvency is a fatal disease; illiquidity is a bad cold, perhaps a very bad cold. It was exactly this distinction that Walter Bagehot had in mind in 1873 when he counseled central banks to lend freely (to relieve illiquidity problems) against good collateral (because only solvent institutions can post enough collateral).

But here’s the problem. A company facing a severe cash squeeze—especially if its usual suppliers of funding have turned their backs on it—may be forced into fire sales of its less liquid assets. Which may mean selling them at exceptionally low prices, if, indeed, it can sell them at all. Which reduces net worth. The problem is worse if you’re a financial company, for at least two reasons. One is that moving cash is your business. Your daily inflows and outflows of cash are likely to be extremely large compared with, say, a comparably sized manufacturing company. The second is that your leverage is likely to be high enough that even modest percentage declines in asset values translate into severe percentage declines in net worth. And it’s much worse if lenders and counterparties lose confidence in you, for then the credit spigot may be turned off. That’s what Paulson meant when he said, “When confidence goes, it goes.”

For these reasons, a severe liquidity crunch can destroy a financial company, such as a commercial bank or an investment bank, even if its balance sheet is basically okay. Illiquidity can turn into insolvency—as happened to Bear Stearns and, later, to Lehman Brothers.