Based on a May 1, 2016 speech by William C. Dudley "Marketing and Funding Liquidity: An Overview" https://www.newyorkfed.org/newsevents/speeches/2016/dud160501 "I would define market liquidity as the cost -- both in expense and time -- of buying or selling an asset for cash." "By funding liquidity, I mean the ability of a financial entity to raise cash by borrowing on either an unsecured or a secured basis." Shadow Bank assets | liabilities ------------------------------------------- Market Liquidity | Funding Liquidity | As Market liquidity increases, funding liquidity also increases. The money supply increases. Money is created by asset valuations. See the balance sheets below for the graphical representation of the following sequence of steps: Shadow Bank pays Fees to Dealer for Insurance. Dealer pays Fees to Cash Pool for Insurance. When insurance is triggered: Cash Pool pays Insurance to Dealer. Dealer pays Insurance to Shadow Bank. In 2007-2008, Cash Pools stopped paying, Dealers failed, Shadow Bank got no insurance (and/or they didn't buy enough Insurance). Fed buys Assets from Dealers, Shadow Banks. Fed gives Funding to Dealers, Shadow Banks. Fed ensures Cash Pool deposits do not "break the buck." Shadow Bank Dealer assets | liabilities assets | liabilities ------------------------------------------- ----------------------------- Market Liquidity | Funding Liquidity | ---------- | ---------- ---------- | ---------- Assets | Funding Funding | Assets | Assets | Funding ---------- | ---------- ---------- | ---------- Insurance | Fees Fees | Insurance | Insurance | Fees | | Dealer Cash Pool assets | liabilities assets | liabilities ----------------------------- ----------------------------- | | ---------- | ---------- ---------- | ---------- Funding | Assets Assets | Funding Assets | Funding | ---------- | ---------- ---------- | ---------- Fees | Insurance | Insurance | Fees Fees | Insurance | ---------- | ---------- | Deposits | Fed assets | liabilities ----------------------- Assets | Funding | Such a system, guided by the fickle drunken walk of a psychology that fixes asset prices arbitrarily, fills me with more and more disgust as I learn about it. I want not to participate in such a perverse, screwed-up system, where lying signals sent with confidence cover up secret balance-sheet shenanigans. --- Note: Professor Mehrling in his Lecture 21 Notes has Insurance as a liability of Asset Managers (I used "Cash Pool"): see http://subbot.org/bsagent/dialogs/derivativedealers.png I have since updated the balance sheets above. Mehrling also does not mention Fees.