Liquidity is the ease with which an asset can be converted into cash without losing value. Cash is perfectly liquid. A savings account is nearly as liquid. A stock is liquid if it trades heavily. A house is not. Selling a house takes months and costs thousands in fees. The difference is liquidity.

Markets have liquidity when there are many buyers and sellers. The bid-ask spread, the difference between the highest price a buyer will pay and the lowest price a seller will accept, measures it. A tight spread means liquid. A wide spread means illiquid. During the 2008 crisis, markets for mortgage-backed securities froze. There were no buyers at any price. That illiquidity turned a credit problem into a systemic crisis.

Banks must manage liquidity carefully. They hold liquid assets, like government bonds and central bank reserves, to meet withdrawals and loan demand. Regulators require them to hold enough high-quality liquid assets to survive a 30-day stress scenario, a rule known as the liquidity coverage ratio. The failure of Silicon Valley Bank in 2023 was partly a liquidity failure. The bank held long-term bonds that lost value as rates rose. When depositors withdrew, the bank had to sell those bonds at a loss, which wiped out its capital.

Liquidity is confidence. When confidence disappears, liquidity disappears with it.