Liquidity is the ease of turning an asset into cash quickly without giving up much of its value to get the sale done. Cash is the benchmark, a Treasury bill comes close, and a house, a private business or a rarely traded bond sits far away. FINRA's investor guidance frames it as how easily an investment can be bought or sold at a fair market price when its owner wants to. For savers comparing the options in the safe investments hub, liquidity decides which money can cover a bill this week and which can only cover one next year.
What is the difference between market liquidity and funding liquidity?
Market liquidity is the ability to buy and sell an asset, while funding liquidity is the ability to obtain financing, typically by pledging assets as collateral. Those are the definitions in a November 2021 staff report on the Treasury market by the Treasury Department, the Federal Reserve Board, the New York Fed, the SEC and the CFTC.
Market liquidity belongs to the asset. Shares of a large company change hands all through market hours, so a seller can expect a buyer within seconds at a price near the last trade. A small municipal bond issue may go weeks without a trade, and an owner who needs cash today may have to accept a markdown to get a bid.
Funding liquidity belongs to the borrower. A bank funds its loans with deposits, a securities dealer finances its inventory with overnight repurchase agreements, and a leveraged fund posts margin on its futures. Each depends on that funding rolling over. When depositors leave, lenders demand more collateral or margin calls arrive, the borrower has to find cash at once, and selling assets is often the quickest way.
The two kinds feed each other. In a 2007 paper, economists Markus Brunnermeier and Lasse Heje Pedersen showed that traders can supply market liquidity only as far as their funding allows, while their funding, through capital and margin requirements, depends on how easily their assets trade. A shock to either side can set off a liquidity spiral, which helps explain why liquidity tends to vanish suddenly, across many securities at once and together with rising volatility.
Households hold both kinds too. A savings balance or a fund position is market liquidity, and an unused credit line is funding liquidity. A home equity line of credit, whose variable rate may be pegged to the prime rate, shows why the second kind is weaker: Regulation Z lets the lender block new draws or cut the limit while the home's value is significantly below its appraised value, or when it reasonably believes a material change in the borrower's finances will prevent repayment. Both conditions are most likely in a downturn, when the line would be most useful.
How is market liquidity measured?
Four measures do most of the work: the bid-ask spread, the depth of the order book, the price impact of trades and trading volume.
| Measure | What it shows | Treasury market reading, March 2020 |
|---|---|---|
| Bid-ask spread | Gap between the best bid and the best offer, the cost of buying and selling at once | 10-year note at 1.4 ticks by March 13, against a typical 0.5 |
| Depth | Quantity offered at the best bid and ask, so how large an order fills at the quoted price | 5- and 10-year notes as low as 10% of their post-crisis averages |
| Price impact | How far the price moves per $100 million of net buying or selling | Five to six times its post-crisis average on March 12 and 13 |
| Trading volume | How much changes hands | More than $1 trillion a day in the week ending March 4, about twice the post-crisis average |
The spread is easiest to compare across securities as a share of the midpoint price:
FINRA warns that a tight spread alone can mislead. An order larger than the quantity offered at the best price eats through the next levels of the book and fills at worse prices, the cost covered under slippage, while the bid-ask spread entry prices a round trip in stocks and funds.
Volume needs the most care. Busy markets are usually liquid ones, but in stress high volume can mean that everyone is trying to trade at once. The New York Fed found record Treasury volume in the week ending March 4, 2020, followed within days by depth comparable with the low point of the 2007 to 2009 crisis, and noted that heavy volume also came with illiquidity around the near-failure of the hedge fund Long-Term Capital Management.
Worked example: What wider Treasury spreads cost in dollars
Treasury prices are quoted per $100 of face value, and the staff report counts a tick as 1/32 of $1, so one tick is $0.03125 per $100, or $312.50 on $1 million of notes.
- 10-year note, typical: 0.5 tick × $312.50 = $156.25 per $1 million
- 10-year note, March 13, 2020: 1.4 ticks × $312.50 = $437.50 per $1 million
- 30-year bond: just over 1/32 on February 28, over 5/32 on March 11 to 13 and 2/32 on March 31, or just over $312.50, over $1,562.50 and $625.00 per $1 million
On $10,000 of the 10-year note, the March 13 spread came to $4.38, against $1.56 in normal trading. These are quotes between dealers, and prices offered to individual customers can be wider.
What happened to Treasury market liquidity in March 2020?
The world's deepest bond market seized up for about two weeks as a broad range of investors sold for cash and dealers ran out of room to absorb it.
The selling was a scramble for dollars. Foreign central banks raised cash to support their currencies, open-end funds met redemptions, many pension funds and life insurers rebalanced from Treasuries into stocks, and leveraged funds cut positions as volatility soared. The staff report puts open-end mutual funds' net Treasury sales at an estimated $266 billion in the first quarter and hedge funds' at a net $173 billion in March, and finds that official institutions made more than half of foreign net sales.
Worked example: The dash for cash in the Treasury market, March 2020
- February 28: cash Treasury trading reached a new high of more than $1.3 trillion in one day, against a daily average of about $600 billion.
- March 9: the 10-year yield stood at 0.54%. The New York Fed dates the worst illiquidity from March 9 to March 24.
- March 15: the FOMC cut its target range to 0 to 1/4% and said it would raise its holdings by at least $500 billion of Treasuries and $200 billion of agency mortgage-backed securities over coming months.
- March 18: the 10-year yield had climbed to 1.18%, up 0.64 percentage point in seven trading days. Foreign official holdings in custody at the New York Fed fell $42 billion that week, and the Fed set up a facility to help money market funds meet redemptions.
- March 23: the FOMC dropped its dollar amounts and committed to buy "in the amounts needed to support smooth market functioning."
- March 25 and 26: primary dealers' net bill inventory had fallen from $23 billion on March 11 to $1 billion by March 25, and by March 26 about 60% of bill trades were at negative yields.
- March 31: the Fed had bought $775 billion of Treasuries and $291 billion of agency MBS since March 15, and the 30-year bond's spread was back to 2/32.
Both kinds of liquidity failed together. In cash-futures basis trades, rising futures prices produced mark-to-market losses on short futures, the clearinghouse raised initial margin and some funds struggled to get repo financing, a funding squeeze that led some to unwind. Their sales landed on dealers who had hit internal balance sheet limits, a market squeeze. In the second week of March, stock and Treasury prices even fell together, reversing their usual pattern.
The cash went to the shortest instruments. Government money market funds took in $838 billion of net inflows during March while prime funds had net outflows, and money funds' Treasury holdings rose by $312 billion, $221 billion of it in bills. That is how 10-year yields could rise while some bill yields dropped below zero. For a saver, the lesson cuts both ways: long-dated Treasuries can be expensive to sell in a panic because the price and the spread move against the seller at once, while bills, insured deposits and government money funds did the job cash is meant to do.
How do you build a liquidity ladder for personal cash?
Sort savings by how soon each dollar might be needed, then give each slice the best yield available among places that can return it in time.
| Rung | Where it can sit | What stands between you and the cash |
|---|---|---|
| Today or tomorrow | Checking, savings and money market deposit accounts at an insured bank or credit union | Little at the same institution; a transfer to another bank adds processing time. The Fed deleted Regulation D's federal cap of six convenient savings withdrawals a month in April 2020 |
| Within about three business days | A government money market fund, or Treasury bills and other securities already held at a broker | A fund must pay within seven days under federal law, except while the New York Stock Exchange is closed or restricted, in an emergency or by SEC order; a Treasury sale typically settles the next business day, and a stock or ETF sale settles One business day after the trade (T+1), since May 28, 2024 |
| In months | CDs, Treasury bills held to maturity, I bonds | A CD's early withdrawal penalty; a market price for brokered CDs or bills sold early; for I bonds, Not cashable for 12 months; cashing before 5 years forfeits the last 3 months of interest |
Each rung can be sized in months of essential spending:
Two details change the timing. Bills bought in TreasuryDirect cannot be sold there: a new security must be held 45 days before it can be sold or transferred to a broker, so a 4-week bill held there runs to maturity, and the guide to selling Treasuries before maturity covers the transfer. A CD's penalty is set by its agreement, and Regulation D adds a minimum of seven days' simple interest on money withdrawn within six days of deposit.
Worked example: Months of cover from a three-rung cash ladder
A household spends $3,500 a month on essentials and keeps five months, $17,500, across three rungs.
- Rung one, today: $3,500 in checking and savings, or $3,500 ÷ $3,500 = 1 month of cover
- Rung two, within three business days: $7,000 in a government money market fund, bringing cover to ($3,500 + $7,000) ÷ $3,500 = 3 months
- Rung three, in months: $7,000 in a 6-month CD or 26-week bills, for $17,500 ÷ $3,500 = 5 months in all
If rung three is needed early, the cost depends on the wrapper. Assume the CD pays 4.00% and its agreement charges 90 days' simple interest: $7,000 × 0.04 × 90 ÷ 365 = $69.04. A bill with 91 days left gives up $7,000 × 0.0008 × 91 ÷ 360 = $1.42 if the seller pays the whole spread the 3-month bill showed in late March 2020, nearly 8 basis points, and $0.18 at the 1 basis point of mid-February 2020.
The penalty, not the spread, is what makes a slow rung costly to tap early, so it should hold only money that can truly wait. Current yields for each bill term are on the T-bill rates page, and the Treasury bill calculator prices a rung from its discount rate. The emergency fund guide picks accounts for each tier, how much to keep in an emergency fund sets the total, and where to park cash short term matches Treasury bill maturities to expenses with known dates.
How does liquidity differ from solvency, volatility and safety?
Liquidity answers one narrow question, how fast and how cheaply something becomes cash, and three neighboring ideas get confused with it.
| Term | The question it answers | How it differs from liquidity |
|---|---|---|
| Solvency | Are assets worth more than debts? | A solvent firm can still fail if creditors want cash faster than it can sell or borrow against its assets |
| Volatility | How far does the price swing? | Large company shares trade easily and can still move sharply, and thin markets and big swings often arrive together |
| Safety of principal | Will the amount put in come back? | An insured CD repays its principal at maturity but charges to leave early; a stock fund can be sold today at whatever price the market sets |
| Liquidity risk | What if a sale or a loan is not available in time? | The chance that liquidity fails when it is needed, one of the risks compared in types of investment risk |
| Credit spread | How much extra yield does a bond pay over Treasuries? | Part of the spread pays for default risk and part for being harder to sell |
Silicon Valley Bank shows how fast a funding run can sink a bank. Depositors withdrew over $40 billion on March 9, 2023, management expected over $100 billion more on March 10, and the Fed's review puts the two together at roughly 85% of the deposit base. The bank lacked the cash and collateral to pay, and California regulators closed it that morning. At the end of 2022, 94% of its parent's deposits were uninsured, against 41% at comparable large banks. Two days after the closing, regulators chose to protect all depositors, insured or not, but savers who stay within $250,000 per depositor, per insured bank, per ownership category need no such decision, as the FDIC insurance guide explains.
Where do you see liquidity as an investor?
Liquidity rules sit in fund regulations, trading screens and redemption terms, mostly as limits and fees rather than headline numbers.
- Money market funds. SEC Rule 2a-7 requires at least 25% of total assets in daily liquid assets and at least 50% in weekly liquid assets, bars buying illiquid securities beyond 5% of total assets, and makes funds other than government and retail funds charge a liquidity fee on any day net redemptions exceed 5% of net assets. The guide to how money market funds work shows the fee math.
- Stocks and ETFs. FINRA notes that large-cap stocks are usually more liquid than small and micro-caps, that extended-hours sessions offer less liquidity, and that a limit order controls the price but may not fill.
- Bonds. Treasuries are among the easiest securities to sell, but FINRA says liquidity varies from one bond to another, and in March 2020 spreads widened most for longer maturities and older, off-the-run issues.
Common liquidity mistakes
- Counting credit as savings. A home equity line can be frozen or cut just when it is needed, so it is a backup, not a rung.
- Reading volume as liquidity. Heavy trading can signal a stampede, as it did in Treasuries in early March 2020.
- Keeping near-term money in long bonds. The 10-year yield's jump from 0.54% to 1.18% in March 2020 cut long Treasury prices just as sellers needed cash.
- Locking up a reserve. I bonds cannot be cashed in their first year, and a CD's penalty for leaving early is set by its agreement, so read it before buying.