Bonds Are Making a Comeback on the NYSE, Reverting Back to the 1940s (Video)

Img: NYSE Bonds (Youtube)
Good news. Corporate bonds are making a comeback on the NYSE, and shifting away from the OTC market. "NYSE Bonds allows customers to see live executable prices in real-time". Next up, leveraged loans and covered mortgage bonds? In a weird turn of events back in the 1940s, corporate bonds and municipal bonds disappeared from the NYSE and started trading OTC (over-the-counter) via dealers. This paper tries to figure out why.

So, illiquid, inefficient and non-transparent trading in the public credit market (in size) has been going on for 70 years. Add OTC credit derivatives (credit default swaps) to the mix, and it seems like the public credit market is just one big legal insider trading scheme between banks, their institutional clients (hedge funds, private equity firms, institutional investment managers), public company board members (which could include hedge funds), and probably Congress, leaking material (or "confidential"?), non-public information between one another while trading public debt securities and/or credit default swaps (synthetic exposure to the public company's debt). No expert networks needed! And other than owning more than 5% or 10% of a company's stock, none of these long or buy-to-open transactions have to be reported in 13F SEC filings, except for convertible debt securities and equity options (puts and calls), and total return swaps in 13D SEC filings. Any thoughts on this? Again, I'm not saying any of this is illegal.

In the early 2000s, someone realized that there was no transparency in the bond market. So FINRA created the TRACE quoting system, which shows recent bond transactions and prices (and historical charts at FINRA's site). So +1 for transparency. Public company debt, the safest part of a company's balance sheet to invest in, should be traded by high frequency robots on exchanges just like the riskiest part of the balance sheet: public equity (common stock). It is funny to me that anyone can trade illiquid OTC penny stocks listed on the OTC Bulletin Board (interdealer electronic quotation system) or Pink OTC Markets using any online discount brokerage. And they are mostly frauds! Why isn't this liquidity trading distressed bonds on the NYSE? The research paper also mentions that bonds traded more frequently on the NYSE than OTC, and transaction costs were lower for retail investors.

I found interesting research papers on the bond market that you might find interesting. See a list of links to pdf files below. Read this abstract from the paper: "The Microstructure of the Bond Market in the 20th Century" by Bruno Biais and Richard C. Green on August 29, 2007.

"Bonds are traded in over-the-counter markets, where opacity and fragmentation imply large transaction costs for retail investors. Is there something special about bonds, in contrast to stocks, precluding transparent limit-order markets? Historical experience suggests this is not the case. Before WWII, there was an active market in corporate and municipal bonds on the NYSE. Activity dropped dramatically, in the late 1920s for municipals and in the mid 1940s for corporate, as trading migrated to the over-the-counter market. The erosion of liquidity on the exchange occurred simultaneously with increases in the relative importance of institutional investors, who fare better in OTC market. Based on current and historical high frequency data, we find that average trading costs in municipal bonds on the NYSE were half as large in 1926-1927 as they are today over the counter. Trading costs in corporate bonds for small investors in the 1940s were as low or lower in the 1940s than they are now. The difference in transactions costs are likely to reflect the differences in market structures, since the underlying technological changes have likely reduced costs of matching buyers and sellers."

Lastly, how is there not a trillion dollar online banking and credit market revolution going on right now after the 2008 financial crisis, government bailouts and ongoing financial frauds at I-banks and brokerage firms (MF Global for example). There should be online Social Investment Banks, and every market, including credit fraud hedges (credit derivatives), should be open to all investors on exchanges.

NYSE managing directors explained how NYSE Bonds would benefit retail investors.

"NYSE Bonds has a full centrally transparent limit order book. So what this allows, it allows customers to see live executable prices in real-time."

"You can view the markets by typing in a ticker symbol, viewing the bonds for that symbol, and then drilling into each individual bond to view the depth of the market in that bond. It now allows the retail investor, the individual investor, to interact with the bond market much like the equity and the option market."

"The other thing that's very important about our platform is it allows customers to send limit orders to the book. So, if you see a bid that you like, you can send your order in and hit that bid. If you see a bid that you don't like, you can actually offer your bonds out on our platform. And you can see that order resting in the order book, so you can see that you're being represented in the marketplace."




"On Friday 14 October Hanzevast Capital listed €2.6 million worth of subordinated bonds to finance a shipping fund. Listing is expected to increase the tradability and liquidity of the bond, making it a more attractive investment. The listing is sponsored by SNS Securities." (NYSE Euronext)





Reading:

Latent Liquidity and Corporate Bond Yield Spreads - http://archive.nyu.edu/bitstream/2451/26304/2/07-13.pdf

Liquidity of Corporate Bonds - http://web.mit.edu/wangj/www/pap/bond_liquidity080322.pdf

Transparency and the Corporate Bond Market - http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1082459

Market Transparency, Liquidity Externalities, And Institutional Trading Costs in Corporate Bonds* - http://web-docs.stern.nyu.edu/salomon/docs/Credit2006/SSRN-id644624.pdf

Corporate Bond Market Transaction Costs and Transparency - http://www.afajof.org/afa/forthcoming/2922.pdf

*Exchange Traded Bonds? http://www.istockanalyst.com/finance/story/5174267/exchange-traded-bonds

The Microstructure of the Bond Market in the 20th Century - http://neeo.univ-tlse1.fr/502/1/bondmarket.pdf

Transparency and Liquidity: A Controlled Experiment on Corporate Bonds - http://faculty.babson.edu/sirri/research/BBB%20RFS.pdf

Revisiting Insider Trading in the Debt Markets: Lessons For Debt Investors and Members of Committees in Bankruptcy Cases - http://friedfrank.com/siteFiles/Publications/D9AEF1BFA85277A4C3383C24032D8725.pdf

Insider Trading and Conflicts of Interest: Evidence from Corporate Bonds - http://centerforpbbefr.rutgers.edu/20thfea/financepapers/session10/kedia,%20and%20zhou.pdf

Prosecuting insider trading in CDS - http://blogs.reuters.com/felix-salmon/2010/03/31/prosecuting-insider-trading-in-cds/

Insider Trading in Credit Derivatives - http://www.ecb.int/events/pdf/conferences/jcbrconf4/Johnson.pdf

Credit-Default Swaps May Incite Regulators Over Insider Trading (2006) - http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aAMb0.6cgOLs

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