This paper presents a simple model of liquidity demand and supply. We show that competitive market forces fail to lead to efficient supply of liquidity. The market provision of liquidity is generally too low when the probability of liquidity event is small and is too high when the probability of liquidity event is large. Moreover, we show that different policy interventions have different efficiency consequences under different market conditions. For example, while subsidizing liquidity providers ex ante (e.g., designated market makers) is generally efficient, the market liquidity might be too high especially when the probability of liquidity event is small; while subsidizing sellers in the spot market (e.g., relaxing capital requirements, subsidizing loan modifications, or purchasing of toxic assets) can reduce the cost of immediate default, it reduces the incentives of other market participants to provide liquidity, both ex ante and ex post, and generally reduces welfare.