The following citations come from an interesting blog article entitled Finance As Magic which can be found here .
It's surprising that Finance exists at all. Theoretically, Finance doesn't seem possible. It's just too far-fetched to expect it to work in practice. It's just a confidence trick; it all depends on trust.
We can't all rush to the exits and exercise our options to sell at the same time. If we tried to, we would soon discover that liquidity is an illusion. The magic only works if we believe in it.
The reference to the article from which these provocative thoughts come is the excellent blog Interfluidity and this piece by Steve Waldman is well worth reading as it stimulated some thoughts of my own on the really difficult question about modern markets - why should overall or systemic liquidity be taken for granted?
One of the insights from behavioral finance is that most people believe that they have above average skills and, even if they may have a gloomy view about the future of the economy/society as a whole they remain upbeat about their own futures. This is the over-confidence illusion, and along with other distinctly human foibles, allows there to be a constant stream of participants willing to play in financial markets and engage in other risk based activities. Of course, it is all based on the fallacy - at least from the point of view of the financial system as a whole - that each of the punters believes that he/she will be able to make their exit from the "game" before the crowd gets wise to the fact that liquidity can only exist at the margin and not for all. The ultimate and malign fallacy that should be the real lesson from recent financial history especially, is that the notion of macro or systemic liquidity is an oxymoron.
It is to the credit of the magicians at the investment banks who perform their conjuring tricks in the world of modern finance that they have crafted so many cunning instruments of opacity and obfuscation that they have been able to mystify and ensure the continued approval and compliance of so many supposedly sophisticated risk managers, credit rating agency analysts and policy makers - or to give them their proper description - products of a credentials…
