Morgan Stanley went on the record yesterday arguing that market liquidity will likely vanish in the event of turmoil. The bank says that the reduction in bank participation in trading, brought on by post-Crisis regulation, has led to “shadow banks” taking up the burden of liquidity. Such shadow banks including entities like professional trading firms, hedge funds etc. However, Morgan Stanley points out that this type of liquidity provider has never been tested in a tumultuous market, and that liquidity is likely to vanish.
FINSUM: While there may be some truth to it, banks love to over play the amount of liquidity they provide in periods of turmoil. When the market gets ugly, they tighten up just like everyone else.