Neil Irwin has a very good piece on how financial markets are going haywire in ways that go beyond plunging stock prices. But what's going on? 1/ nytimes.com/2020/03/12/ups…
Almost surely we're in Shleifer-Vishny territory — that is, suffering from the problems they diagnosed in a classic 1997 paper titled "The limits of arbitrage" 2/ scholar.harvard.edu/files/shleifer…
Their point was that smooth functioning of financial markets depends on "arbitrage" — investors moving in to buy obviously underpriced assets. But arbitrage isn't carried out by large numbers of small investors; it's done by specialized players in particular markets 3/
And when there are extreme movements in asset prices, these specialized players — who are usually quite leveraged — are crippled by lack of adequate capital, and can't do their job. They may even be forced into fire sales of assets they know are underpriced 4/
There was a lot of that in 2008-9, and now it's happening again. The Fed is trying to stabilize thing by rushing in a lot of liquidity, but this money may not reach the places it needs to go. One more thing to get very worried about 5/
