Higher liquidity leads to a decline in transaction costs (bid/ask spread + commissions) and therefore: a decrease in risk premium. If you are able to sell your assets quickly at the current market price, the perceived risk is lower – not only for you as an investor, but also for your creditors. Liquid secondary markets cause a decline in risk premium, which by definition leads to an increase in the value of the traded financial assets.
The existence of liquid secondary markets is essential condition for developed IPO markets. Secondary markets are the main exit strategy for IPO investors, therefore the higher the liquidity the higher the interest in IPOs.
IPOs are an effective tool for venture capitalists and entrepreneurs to transfer part of the risk to the public; to get paid for their work or simply to raise more capital for further expansion. In the same time investors (the public) receive the opportunity to participate in the growth of a promising business. There is no doubt that without enough interest in IPOs (which is a derivative of secondary markets’ liquidity), venture capital and entrepreneurs will be robbed from one of their main exit strategies; therefore VC funds are likely to raise much less money and less projects will be funded. The end result is less start ups, less entrepreneurs, less jobs, slower technological progress and ultimatelly lower living standard for everyone.
Hopefully the Congress will not take short-sighted decisions that are going to worsen the liquidity of US secondary capital markets. Am I opposing new regulations? No – the systemic risk in the economy needs to be addressed and intelligent changes in regulation are needed. The simple, but optimal approach to decrease systemic risk is to limit the size of leverage and prevent “too big to fail” companies to participate directly or indirectly in OTC deals. If you are “too big to fail”, you need to be accountable and transparent. If you don’t like it, become too small to matter for the survivability of the financial system.
The most powerful forces against poverty are technological progress and entrepreneurship, which scope and success are directly dependent on the liquidity of secondary capital markets. Don’t kill the liquidity.
