“Liquidity Is The Last Refuge Of The Scoundrel”

Joseph Saluzzi (jsaluzzi-at-ThemisTrading.com) and Sal L. Arnuk (sarnuk-at-ThemisTrading.com) are co-heads of the equity trading desk at Themis Trading LLC (www.themistrading.com), an independent, no conflict agency brokerage firm specializing in trading listed and OTC equities for institutions. Prior to founding Themis, Sal and Joe worked for more than 10 years at Instinet Corporation, pioneers in the field of electronic trading, and at Morgan Stanley.


Liquidity could be one most overused and misunderstood terms on Wall Street. Liquidity is a term that is usually rolled out when self-interested parties are looking to defend their highly profitable business models. How many times have you heard the HFT industry say “we provide liquidity”? We are also seeing a lot of “liquidity” comments from the big banks who are trying to squash the Volcker rule. The banks are warning that if you force them to shed their proprietary trading areas then the market will suffer because of a “lack of liquidity”. But the question becomes, how much liquidity is actually needed?

In a comment letter on his own rule, Paul Volcker addressed this liquidity issue:

“At some point, great liquidity, or the perception of it, may itself encourage more speculative trading, even in longer-term instruments. Presumably conservative institutional investors are tempted to turn over positions much more rapidly, at the expense of careful analysis of basic values. In the light of events, careful consideration of the benefits and possibly damaging consequences of increased liquidity has become the subject of new studies and commentary by economists and regulators. A consensus may be developing that beyond some point, little or no public benefit may be evident.”

Volcker also addressed the liquidity issue at a recent event (15 minute mark of video) with John Bogle, the Vanguard Group founder:

Liquidity is partly a state of mind. Is there such a thing as too much liquidity that is misleading people into investment behavior that is damaging to the economy?”

John Bogle then added his opinion on liquidity:

“Samuel Johnson had a saying that Patriotism is the last refuge of the scoundrel. And I have an idea that liquidity is the last refuge of the scoundrel.”

All this trading creates nothing, creates no value, in fact, subtracts from value.”

“IPOs and secondaries amount to about $200 billion per year, but last year we had $40 trillion of trading in the US securities. There is 200 times as much speculation as there is investment ..or investment accounts for 0.5% of the function of Wall Street.”

Lord Adair Turner, chairman of the FSA, questioned the value of “liquidity” in a 2010 speech :

A reasonable judgement on the economic value added of increased liquidity does deliver benefits but subject to diminishing marginal utility, and the increased financial speculation required to deliver increased liquidity creates an increasing danger of destabilising herd and momentum effects, the larger pure financial activity becomes relative to underlying real economic activity.”

Was the oil market liquid on Monday when an algo decided to quote blast it? Was Amazon liquid yesterday when a headline crossed that caused the stock to drop 3% in seconds only to rebound minutes later? Was the stock market liquid in the last 20 minutes of trading yesterday as shorts scrambled to cover on another Greek rumor? Liquidity is partly a state of mind.

We hear all too often how today’s market is filled with liquidity but yet many traders that we speak to don’t seem to think that the markets are very liquid. All too often they enter the market, only to watch the liquidity that they thought was there disappear right before their eyes. The next time you friendly neighborhood bank or HFT tells you that he adds liquidity for the good of the market, let him know what he could do with his liquidity.

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