WEBVTT - Here's Why It's So Hard to Fix the Corporate Bond Market 0:00:10.760 --> 0:00:14.320 Hello, and welcome to another episode of the Odd Lots Podcast. 0:00:14.440 --> 0:00:17.880 I'm Tracy Alloway. My co host Joe Wisenthal. Is a 0:00:17.920 --> 0:00:21.440 way which means I get a chance to talk about 0:00:21.440 --> 0:00:24.439 one of my all time favorite topics, which has to 0:00:24.560 --> 0:00:29.360 be bond market structure um and particularly the evolution or 0:00:29.720 --> 0:00:33.760 sometimes lack thereof, of that structure and the way that 0:00:34.040 --> 0:00:38.920 a massive, massive market is actually traded. So when people 0:00:38.960 --> 0:00:41.600 think about the corporate bond market, I think there's a 0:00:41.640 --> 0:00:46.599 tendency to think way back to sort of liars poker 0:00:47.240 --> 0:00:51.600 era corporate bond trading, like this was the big business 0:00:51.640 --> 0:00:54.400 on Wall Street. People made lots of money from it, 0:00:54.840 --> 0:00:58.640 You had certain personalities that were tied to it, and 0:00:58.680 --> 0:01:01.480 it was sort of old fashioned the way bonds were traded. 0:01:01.840 --> 0:01:05.520 And then fast forward to you know, post financial crisis, 0:01:05.959 --> 0:01:10.039 the two thousand tens, and surprisingly, even as the stock 0:01:10.080 --> 0:01:14.720 market had largely electronified, the corporate bond market was still 0:01:14.840 --> 0:01:19.160 pretty much operating like it had in even the nine eighties. 0:01:19.240 --> 0:01:23.679 You know, trades done by phone, some trades done by facts, 0:01:23.760 --> 0:01:26.080 kind of amazingly, and then if you fast forward to 0:01:28.240 --> 0:01:31.200 one We've spoken a lot on the show about the 0:01:31.240 --> 0:01:35.679 idea of the pandemic forcing or increasing the rate of 0:01:35.800 --> 0:01:39.840 digitalization in the broader economy, the idea of everyone ordering 0:01:40.000 --> 0:01:43.800 stuff online and more things just moving to the cloud 0:01:44.000 --> 0:01:49.520 and computerized processes. Interestingly, it seems like the pandemic has 0:01:49.560 --> 0:01:52.600 had a little bit of that effect on the corporate 0:01:52.640 --> 0:01:55.320 bond market as well. So we've actually seen the proportion 0:01:55.440 --> 0:01:58.920 of corporate bond trades that are electronic go up. The 0:01:58.960 --> 0:02:01.360 most recent research I saw, I think it was from 0:02:01.360 --> 0:02:06.920 Greenwich Associates, had electronic trading as a proportion of overall 0:02:07.080 --> 0:02:11.720 investment grade corporate bond trading at about forty of the 0:02:11.760 --> 0:02:15.880 total UH. That is up from I think at the 0:02:15.880 --> 0:02:21.240 beginning of and up from a minuscule one tenth of 0:02:21.280 --> 0:02:24.600 total trading in eleven. So that tells you how far 0:02:24.680 --> 0:02:28.639 we've come, But of course there is much further to go, 0:02:28.840 --> 0:02:32.720 and there have been efforts to reform corporate bond trading 0:02:32.919 --> 0:02:35.480 the way it's done for many, many years now, and 0:02:35.600 --> 0:02:39.040 one of the most interesting developments in that space has 0:02:39.080 --> 0:02:44.160 been the establishment of the Fixed Income Market Structure Advisory 0:02:44.200 --> 0:02:48.320 Committee by the SEC. This was created back in with 0:02:48.520 --> 0:02:53.320 the intention of improving the fixed income market and encouraging 0:02:53.840 --> 0:02:57.120 its development So today I'm very pleased to say that 0:02:57.120 --> 0:02:59.519 we are going to be checking in on what's going 0:02:59.520 --> 0:03:02.320 on with the corporate bond market, whether or not Fim 0:03:02.320 --> 0:03:06.080 Sack has been able to fix it or you know, 0:03:06.120 --> 0:03:08.960 at least improve it moderately. We're gonna be doing that 0:03:09.000 --> 0:03:11.359 with the perfect person. We're going to be speaking with 0:03:11.720 --> 0:03:15.040 Larry Harris, who was on film Sack so on the 0:03:15.160 --> 0:03:19.400 SEC committee. He's also the former chief economist at the SEC. 0:03:19.680 --> 0:03:21.800 He was there from two thousand two to two thousand 0:03:21.919 --> 0:03:25.120 four and he is currently the Fred V. Keenan Chair 0:03:25.160 --> 0:03:29.840 in Finance at the USC Marshall School of Business. So, Larry, 0:03:29.960 --> 0:03:32.160 thanks so much for coming on the show. Oh, it's 0:03:32.160 --> 0:03:35.920 a pleasure to be here. So maybe just a first question. 0:03:35.960 --> 0:03:39.119 I mean, it sounds like you have been in these 0:03:39.160 --> 0:03:42.960 sort of trading and market micro structure space for a 0:03:43.080 --> 0:03:47.120 very long time. Is this something that you've always been following. Yes, 0:03:47.360 --> 0:03:50.760 I've been working in market microstructure pretty much from the 0:03:50.800 --> 0:03:56.280 beginning of the academic field now probably forty years. So 0:03:56.800 --> 0:04:00.480 given your expertise, I have to ask what that about 0:04:00.560 --> 0:04:04.080 corporate bonds that seems to make them a little bit 0:04:04.080 --> 0:04:10.880 more stubborn when it comes to things like electronic trading standardization, 0:04:11.480 --> 0:04:15.240 uh other efforts to improve liquidity. It feels like the 0:04:15.280 --> 0:04:20.120 corporate bond space, despite people trying to evolve it for 0:04:20.520 --> 0:04:24.880 i mean decades now, it feels like it's definitely an 0:04:24.960 --> 0:04:29.119 uphill battle. Tracy, that's a great question. If you listen 0:04:29.160 --> 0:04:32.040 to the vested interests in the bond market, they'll tell 0:04:32.040 --> 0:04:35.760 you that bonds are just simply different. They're different from equities, 0:04:35.760 --> 0:04:38.560 they're different from options, they're different from futures, and they 0:04:38.560 --> 0:04:42.520 say that the differences are what makes the market structure different. 0:04:43.000 --> 0:04:46.960 Of course, they don't often articulate exactly what those differences are. 0:04:47.480 --> 0:04:50.520 So often they'll tell you that they're different because there 0:04:50.520 --> 0:04:54.080 are so many bonds, but there are even more options 0:04:54.120 --> 0:04:57.640 that trade, and they trade in exchange markets and they 0:04:57.680 --> 0:05:00.800 trade pretty well. They'll tell you that they're because they're 0:05:00.839 --> 0:05:06.479 so risky. Although equities are more risky per dollar of 0:05:06.640 --> 0:05:09.680 principle than our bonds. So it's a it's a little 0:05:09.720 --> 0:05:12.560 hard to understand this question on its face. We're gonna 0:05:12.600 --> 0:05:15.120 have to dig deeper. But as long as we're starting 0:05:15.120 --> 0:05:18.120 with some history. As you started history, um, you started 0:05:18.120 --> 0:05:21.800 around the eighties. I'd like to push it back much further. UH, 0:05:21.839 --> 0:05:25.600 to share with you and our audience some very interesting 0:05:25.640 --> 0:05:28.760 things that many people don't know. Bonds used to trade 0:05:28.880 --> 0:05:32.920 almost exclusively in exchange markets at the New York Stock 0:05:32.960 --> 0:05:37.239 Exchange and at the American Stock Exchange. Corporate bonds stopped 0:05:37.240 --> 0:05:41.360 trading on the exchange markets in the mid forties, UH, 0:05:41.400 --> 0:05:44.880 and an interesting paper was done by two academics, Bruno 0:05:44.920 --> 0:05:48.240 Bier and Rick Green. And what they did is they 0:05:48.279 --> 0:05:53.080 looked to see how those bonds traded in the forties 0:05:53.480 --> 0:05:56.680 and in the late thirties and compared that trading to 0:05:56.839 --> 0:05:59.039 how they presently trade now. And when I say how 0:05:59.080 --> 0:06:02.279 they trade, I'm really referring to how expensive was it 0:06:02.360 --> 0:06:05.279 to trade the bonds. And when I speak about expense, 0:06:05.320 --> 0:06:07.440 I don't call I'm not speaking about the price. I'm 0:06:07.440 --> 0:06:11.080 talking about the transaction costs of trading. So if you 0:06:11.279 --> 0:06:13.360 buy a bond that's worth a hundred but you pay 0:06:13.400 --> 0:06:17.240 a hundred one, then your cost was was one point 0:06:17.279 --> 0:06:21.120 of par value. So these bonds that traded New York 0:06:21.120 --> 0:06:23.919 Stock Exchange. I'll save the result for a moment, but 0:06:23.960 --> 0:06:26.760 you can all anticipate what it's going to be. Let's 0:06:26.760 --> 0:06:31.400 talk about how they traded. So they traded in order books, 0:06:31.440 --> 0:06:34.320 just like the stocks trade, but because there were so 0:06:34.360 --> 0:06:36.599 many bonds, they had to put the order books in 0:06:36.680 --> 0:06:41.000 filing cabinets. And so these order books, these databases were 0:06:41.000 --> 0:06:43.799 contained in filing cabinets. If you wanted to trade a bond, 0:06:43.800 --> 0:06:47.400 you went to the bond specialist post and you mentioned, 0:06:47.400 --> 0:06:49.159 you know, he said what bond you wanted to trade, 0:06:49.160 --> 0:06:51.520 and the clerk would go. The specialists go and look 0:06:51.600 --> 0:06:53.560 up the bond in the filing cabinet, find out who 0:06:53.560 --> 0:06:56.800 had left orders for it. And so now the punchline, 0:06:56.800 --> 0:07:00.240 of course, it is one that everybody's expecting in those 0:07:01.080 --> 0:07:05.240 non electronic but order driven markets. So order driven means 0:07:05.279 --> 0:07:08.679 exchange markets in which you have rules that match buyers 0:07:08.680 --> 0:07:12.040 to sellers. So the most aggressive buyer, the one is 0:07:12.040 --> 0:07:14.520 willing to pay the most gets matched to the most 0:07:14.520 --> 0:07:18.280 aggressive seller, the one who's offering the lowest price. In 0:07:18.440 --> 0:07:22.880 those order driven markets, bonds traded at lower transaction costs 0:07:22.960 --> 0:07:26.320 ages ago. Then they were trading until just a few 0:07:26.400 --> 0:07:30.800 years ago. So so that leaves us with the interesting 0:07:30.880 --> 0:07:34.600 question why why did the markets move away from the 0:07:34.640 --> 0:07:38.480 stock exchange where the stock exchanges Because the AMAX bonds 0:07:38.480 --> 0:07:41.080 were also important. Why did they move away from the 0:07:41.080 --> 0:07:44.040 stock exchanges and into the investment banks and the dealers 0:07:44.040 --> 0:07:47.880 and brokers, So somehow they captured it. And this is 0:07:47.920 --> 0:07:51.280 not really well understood. Bruno Bier and Rick Green speculate 0:07:51.360 --> 0:07:54.640 about it. It's hard to imagine that it made sense 0:07:54.760 --> 0:07:59.320 for the buy side, UH, the investors, because in the 0:07:59.400 --> 0:08:02.440 end they did worse. But um I think it's just 0:08:02.520 --> 0:08:07.640 because the investment banks probably controlled much of the supply 0:08:07.760 --> 0:08:10.400 of bonds. They were buying and selling them. They were dealers, 0:08:10.440 --> 0:08:15.080 and they preferred to trade as dealers then as some 0:08:15.560 --> 0:08:20.120 dealers operating in exchange markets. Of course, dealers always operate 0:08:20.160 --> 0:08:23.280 in exchange markets. There's nothing new there, but they're more 0:08:23.280 --> 0:08:26.200 powerful when they trade in a dark environment where you 0:08:26.240 --> 0:08:30.360 don't see the trade prices and you don't see the quotes. 0:08:31.160 --> 0:08:35.600 Now fast forward and UH two thousand and two to 0:08:35.760 --> 0:08:38.680 oh four or so. At the time I was chief economist, 0:08:38.720 --> 0:08:43.880 the sec FINRA started the Trace bond price reporting project, 0:08:44.760 --> 0:08:49.400 and the dealers were very opposed to having those trade 0:08:49.440 --> 0:08:52.360 prices reported, even with a fifteen minute lag, which is 0:08:52.400 --> 0:08:56.280 what was finally determined. Um I was privileged, along with 0:08:56.760 --> 0:09:01.000 some others to engage in research that showed that making 0:09:01.080 --> 0:09:07.080 those bond prices public information would lower investor transaction costs 0:09:07.080 --> 0:09:11.640 by about a billion dollars per year. So the opposition 0:09:11.679 --> 0:09:14.360 to the dealers to making the prices public kind of 0:09:14.400 --> 0:09:19.040 withered away in the face of those empirical results. I'll 0:09:19.080 --> 0:09:21.800 tell you two fund stories. There's somewhat self serving, but 0:09:22.240 --> 0:09:27.120 does make the point about this story. Yeah. So the 0:09:27.160 --> 0:09:30.720 first one is that, um, so the SEC did indeed 0:09:30.960 --> 0:09:34.160 mandate that the bond trade prices be made public, and 0:09:34.160 --> 0:09:36.720 now trace prices are available on the Internet and everybody 0:09:36.720 --> 0:09:40.040 can see them. So the two stories are. First, um, 0:09:40.120 --> 0:09:42.560 somebody came along, I forget the fellow's name, might have 0:09:42.559 --> 0:09:45.520 been a woman and replicated the study in which I 0:09:45.559 --> 0:09:50.640 participated and discovered that indeed investors were saving billion dollars. 0:09:51.080 --> 0:09:53.800 So my study had been based on just a trial 0:09:54.000 --> 0:09:57.800 of trace and from the bonds that were public, and 0:09:57.880 --> 0:10:00.920 we compared them to the bonds that weren't public publicly 0:10:01.160 --> 0:10:04.160 where the information wasn't publicly available to trade price information. 0:10:05.280 --> 0:10:07.800 From doing the comparison, were able to determine what we 0:10:07.840 --> 0:10:10.840 thought the savings would be. The way we did the study, 0:10:10.920 --> 0:10:16.800 we compared how the bonds that were trading in more 0:10:16.840 --> 0:10:23.080 transparent markets, the initial trace transparent bonds. We compared how 0:10:23.120 --> 0:10:26.599 they traded to the ones that had not yet been converted, 0:10:26.880 --> 0:10:29.520 and we we found that about a billion dollars would 0:10:29.559 --> 0:10:33.319 be saved by investors. And so the first story is that, uh, indeed, 0:10:33.480 --> 0:10:36.319 somebody looked at it a few years later and determined 0:10:36.360 --> 0:10:39.880 that our estimate was was on target. So I I say, 0:10:39.920 --> 0:10:44.600 somewhat immodestly that we did well. But the important point 0:10:44.679 --> 0:10:47.240 is that not only on a prospective basis, but on 0:10:47.280 --> 0:10:51.480 a retrospective basis, it appears that that bond price transparency 0:10:51.960 --> 0:10:55.960 substantially lower transaction costs. So that's the first story. The 0:10:56.000 --> 0:10:59.240 second story is a little bit more fun. And Nette Nazareth, 0:10:59.320 --> 0:11:02.240 who was then the director of what was then called 0:11:02.280 --> 0:11:05.160 the Division of Trading and Markets, who was a big 0:11:05.200 --> 0:11:10.720 proponent of making the bond prices transparent. She kept asking me, Larry, 0:11:10.720 --> 0:11:12.480 how come you're not done with that study? How come 0:11:12.520 --> 0:11:14.679 night you're done done with the study? Because they needed 0:11:14.720 --> 0:11:18.560 that study to build the political wherewithal to get the 0:11:18.640 --> 0:11:22.520 capital to to get this done. And I kept telling her, 0:11:22.640 --> 0:11:25.040 listen and that I'd like to have it done yesterday, 0:11:25.080 --> 0:11:28.920 but we're going to be super careful because the dealers 0:11:29.000 --> 0:11:32.320 are going to criticize this study. So fast forward about 0:11:32.360 --> 0:11:35.040 ten years. I'm at some conference. I'm talking to somebody, 0:11:35.440 --> 0:11:39.240 you know, an academic conference, and uh and this guy 0:11:39.320 --> 0:11:41.720 sort of drops uh. He says, um, you know you 0:11:41.760 --> 0:11:45.760 did that bond study about transaction costs to the initial 0:11:45.800 --> 0:11:48.320 trace down And I said yeah. He says, uh says, 0:11:48.320 --> 0:11:51.960 I know, I know a backstory about that. I'm going yeah, 0:11:52.160 --> 0:11:55.600 he says, he says, the dealers, Uh sent it to 0:11:55.720 --> 0:11:58.240 a colleague of mine at the university. I won't say 0:11:58.240 --> 0:12:02.559 which one, but it was a strong, reputable university, asking 0:12:03.240 --> 0:12:05.880 is there anything wrong with the study? Uh, you know, 0:12:05.920 --> 0:12:10.040 can you find econometric problems or something like that? And Uh. 0:12:10.520 --> 0:12:14.200 The response was apparently no, you're gonna have to live 0:12:14.240 --> 0:12:16.800 with it. It was well done. So again a pat 0:12:16.800 --> 0:12:20.520 on my back. But also also there's a more important point, 0:12:20.559 --> 0:12:24.240 which is that there's a role for academic work. Rigorous 0:12:24.280 --> 0:12:26.520 work didn't have to be done by academic can be 0:12:26.559 --> 0:12:29.280 done by practitioners as well, and by the economists at 0:12:29.320 --> 0:12:33.040 the SEC. There's a role for rigorous work for trying 0:12:33.080 --> 0:12:36.240 to understand how things could be different. I mean, that 0:12:36.360 --> 0:12:40.520 is such a fascinating um insight into the way the 0:12:40.640 --> 0:12:44.520 SEC works and also the way it's various stakeholders um 0:12:44.559 --> 0:12:47.559 sort of interact with it. There's one thing I wanted 0:12:47.600 --> 0:12:49.719 to ask you before we sort of move on to 0:12:49.920 --> 0:12:53.120 what happened next, But can we just can we focus 0:12:53.160 --> 0:12:55.959 in on on the dealers here a little bit more so? 0:12:56.160 --> 0:12:58.720 You know, you you kind of touched on this, this 0:12:58.840 --> 0:13:02.080 idea that the dealers have vested interest in the way 0:13:02.120 --> 0:13:05.600 that the current system works. So I brought up liars 0:13:05.640 --> 0:13:09.000 Poker at the beginning. You know, this is the idea 0:13:09.160 --> 0:13:12.640 of people sitting at the big dealer banks who are 0:13:12.720 --> 0:13:15.200 taking calls from investors who want to buy or sell 0:13:15.280 --> 0:13:19.960 certain bonds. They're basically the middleman who are holding the 0:13:20.040 --> 0:13:22.760 informational power and who can say like, well, I have 0:13:22.800 --> 0:13:24.160 a quote on this one or I have a quote 0:13:24.160 --> 0:13:27.320 on that one, and no one really is quite clear 0:13:27.920 --> 0:13:30.640 what the actual price of these bonds are. They're sitting 0:13:30.679 --> 0:13:33.960 in the middle. It's a very intransparent process. Now, in 0:13:34.000 --> 0:13:37.720 the years since then, we have had these new electronic 0:13:37.760 --> 0:13:40.200 trading venues set up, and here I have to do 0:13:40.240 --> 0:13:44.000 a massive disclosure and say that Bloomberg has one UM, 0:13:44.040 --> 0:13:48.199 so we have Bloomberg Trade Web and market Access, and 0:13:48.240 --> 0:13:54.079 my understanding of those is that basically they've made dealing 0:13:54.160 --> 0:13:58.400 with dealers potentially more efficient. So you can do a 0:13:58.480 --> 0:14:01.280 request for a quote with just you know, a click 0:14:01.320 --> 0:14:03.400 of a button and you can get one very very quickly. 0:14:04.120 --> 0:14:07.880 But they still preserve some of the power of the 0:14:07.960 --> 0:14:11.800 dealers in that process. You can't do a deal directly 0:14:11.880 --> 0:14:16.199 with another buy side participants for instance. Is that right? 0:14:16.280 --> 0:14:19.480 Is that the right way to think about it? Yes, 0:14:19.560 --> 0:14:22.360 that's generally correct. And though they would like to create 0:14:23.080 --> 0:14:26.600 exchange type markets, uh, they know that they still need 0:14:26.640 --> 0:14:28.920 the dealers to provide the liquidity and so that the 0:14:29.040 --> 0:14:32.720 dealers call the shots. Tracy, you're, you're. You use the 0:14:32.720 --> 0:14:36.640 word um informational power. You could not be more on 0:14:36.760 --> 0:14:41.440 target with that phrase. So, just so that everybody listening 0:14:41.480 --> 0:14:45.320 has a clear understanding of how powerful information is, let's 0:14:45.640 --> 0:14:49.600 discuss a simple example of where that everybody can relate to. 0:14:50.080 --> 0:14:53.000 Suppose you need to buy a say a used car 0:14:53.160 --> 0:14:55.080 or could be a new car, uh, and you go 0:14:55.120 --> 0:14:56.920 to the dealer and you find what you want to buy, 0:14:57.160 --> 0:14:59.920 and you you then make a bid. Okay, now, they 0:15:00.200 --> 0:15:03.440 two mistakes that you can make. You can underbid or 0:15:03.480 --> 0:15:07.000 you can overbid. Now, if you underbid, here's what happens. 0:15:07.000 --> 0:15:10.640 So the salesman says, say, Larry, I'd really love to 0:15:10.680 --> 0:15:13.400 sell you that car at that price, but if we 0:15:13.480 --> 0:15:15.520 do that, we just can't stay in business. The price 0:15:15.560 --> 0:15:18.600 is simply too low. So, um, you don't do the deal. 0:15:18.920 --> 0:15:23.000 Now suppose that you overbid. What does the salesman say. 0:15:23.400 --> 0:15:26.440 Salesman says, hey, Larry, I'd really like to sell you 0:15:26.520 --> 0:15:29.440 that car, but if I do so at that price, 0:15:29.840 --> 0:15:31.920 we're going to go out of business. But hang on 0:15:31.960 --> 0:15:34.360 a minute, let me see what my sales manager says. 0:15:35.680 --> 0:15:37.320 And of course he comes back and sells you the 0:15:37.360 --> 0:15:41.400 car at the price that's uh, that's too high. So 0:15:41.440 --> 0:15:44.560 what's going on here? Obviously you can make two mistakes. 0:15:44.600 --> 0:15:47.480 But because the dealer knows values better than you do, 0:15:48.520 --> 0:15:51.240 the dealer isn't gonna sell it for undervalue, but it'd 0:15:51.240 --> 0:15:54.360 be more than happy to sell it for overvalue. And 0:15:54.400 --> 0:15:57.880 so this is the story. This is why information about 0:15:58.040 --> 0:16:02.200 values is so incredibly important. Unfortunately, we only have half 0:16:02.280 --> 0:16:06.200 the story on price values. We've got now the trace 0:16:06.320 --> 0:16:09.000 data that we just talked about which tells you the 0:16:09.080 --> 0:16:13.600 prices at which bonds traded. By and large, we don't 0:16:13.640 --> 0:16:18.200 have very much quotation data, although it's increasing substantially, we 0:16:18.240 --> 0:16:21.920 don't have much quotation data where the dealers are telling 0:16:21.960 --> 0:16:25.840 the public the prices which they're willing to trade. So 0:16:25.880 --> 0:16:27.840 if you want to go buy a bond and you're smart, 0:16:27.880 --> 0:16:30.120 what you do is you you you go and call 0:16:30.200 --> 0:16:32.240 up a dealer and say what's your offer, and then 0:16:32.280 --> 0:16:34.680 you call another dealer and ask for what your offer, 0:16:34.680 --> 0:16:36.200 and you call another dealer and you can sort of 0:16:36.200 --> 0:16:39.040 make them all know that you're doing this, or you 0:16:39.040 --> 0:16:41.200 can do a request for quote, which is essentially the 0:16:41.240 --> 0:16:43.520 same thing, and you try to get them to compete 0:16:43.560 --> 0:16:46.520 with each other. But it's an expensive process and um, 0:16:46.560 --> 0:16:49.720 they're only volunteering information to you, not to the public, 0:16:50.280 --> 0:16:53.320 so it's not quite as effective as the competition we 0:16:53.400 --> 0:16:57.960 see every single day for even a liquid securities at 0:16:58.040 --> 0:17:02.520 the various stock exchange is or the options exchanges. So 0:17:02.560 --> 0:17:07.040 when pricing data became available on trades, you're getting the 0:17:07.320 --> 0:17:11.520 specific points, the specific prices at what which bonds are 0:17:11.840 --> 0:17:16.280 being traded, but you're not getting potential quotes from a 0:17:16.320 --> 0:17:18.920 bunch of dealers about like where they could buy or 0:17:18.960 --> 0:17:22.720 seldom you're getting the actual transaction data. How did that 0:17:22.920 --> 0:17:29.480 change the market or change behavior of participants. Well sophisticated 0:17:29.520 --> 0:17:32.399 people and even some less sophisticated who know enough to 0:17:32.720 --> 0:17:36.119 look up bond prices can find out where the bonds 0:17:36.200 --> 0:17:39.800 recently traded. And if a bond recently traded, you know, 0:17:39.920 --> 0:17:43.040 just minutes ago, then you have a good point of 0:17:43.080 --> 0:17:45.600 reference to what the value that bond is, especially if 0:17:45.640 --> 0:17:48.560 it's a very large trade. The large trades tend to 0:17:48.600 --> 0:17:52.199 be more informative than the smaller trades because the smaller traders, frankly, 0:17:52.680 --> 0:17:54.520 you know, they just don't know as much. They don't 0:17:54.520 --> 0:17:56.800 know how to they don't know how to control the 0:17:56.840 --> 0:18:00.240 information environment. They trade through brokers who aren't particularly how full, 0:18:00.680 --> 0:18:03.760 and so the smaller trade prices aren't so important. But 0:18:03.840 --> 0:18:06.080 if you want to trade a bond, say you're trying 0:18:06.080 --> 0:18:08.040 to sell a bond, is a more typical story than 0:18:08.160 --> 0:18:10.560 wanting to buy one. Uh, you want to sell a 0:18:10.560 --> 0:18:13.960 bond that you need that you need to generate some liquidity. 0:18:14.160 --> 0:18:17.440 Maybe that bond didn't trade yesterday or today, Um, that 0:18:17.480 --> 0:18:20.760 would be ideal. Say it traded last Um, you know 0:18:20.760 --> 0:18:24.679 a month ago or perhaps a year ago. Uh, there 0:18:24.720 --> 0:18:26.320 are a lot of bonding issues out there, and some 0:18:26.440 --> 0:18:29.399 of them, they we say they trade only by appointment, 0:18:29.560 --> 0:18:31.840 which is kind of funny. Okay, so you've got a 0:18:31.880 --> 0:18:34.160 bond trade from ages ago, and now all the question 0:18:34.160 --> 0:18:37.600 is what's the thing worth? And you know there are 0:18:37.760 --> 0:18:41.159 bond pricing services that can give you some sense of 0:18:41.200 --> 0:18:43.600 what the bond is worth. That's very important because mutual 0:18:43.640 --> 0:18:45.879 funds that hold bonds have to value their bonds and 0:18:45.880 --> 0:18:48.120 if they don't trade, well, I mean, what's the bond worth? 0:18:48.119 --> 0:18:51.520 They've got to know every day. So these pricing services 0:18:52.000 --> 0:18:54.440 what they do is they say, okay, this bond didn't trade, 0:18:54.440 --> 0:18:58.040 but it looks a lot like these other bonds, maybe 0:18:58.119 --> 0:19:00.560 bonds by the same issuer, or maybe be bonds with 0:19:00.600 --> 0:19:04.480 the same cupon rate, the same maturity, the same the 0:19:04.560 --> 0:19:08.639 same preference in liquidation, stuff like that. And so they say, okay, 0:19:08.920 --> 0:19:11.760 we got a model that says if if these other 0:19:11.800 --> 0:19:14.640 bonds are sort of recently traded and we see their prices, 0:19:14.680 --> 0:19:18.080 we can infer what this thing is probably worth. Of course, 0:19:18.160 --> 0:19:20.520 you know, the small trader, the guy who's trading odd lots. 0:19:22.440 --> 0:19:25.040 You're on the right show. I know. That's that's why 0:19:25.080 --> 0:19:29.400 I laughed here. Uh. Yeah, they don't get that information 0:19:29.600 --> 0:19:33.320 and it's expensive. And in any event, though, um, what 0:19:33.400 --> 0:19:36.439 the pricing services say is not necessarily true either. It's 0:19:36.480 --> 0:19:39.280 just their best estament. Real truth comes when people are 0:19:39.280 --> 0:19:41.840 ready to put their money on the on the table 0:19:42.320 --> 0:19:46.240 and trade and actually negotiate prices. So it's good to 0:19:46.320 --> 0:19:50.720 have those trace prices, but it would be even better 0:19:50.920 --> 0:19:55.240 if we had perspective prices, pre trade prices. The quotes, 0:19:56.040 --> 0:19:58.040 there are a lot of them out now out there now, 0:19:58.240 --> 0:20:01.520 and uh, entities like bond to click are starting to 0:20:01.560 --> 0:20:05.200 aggregate them from dealers. The dealers are willing to share 0:20:05.280 --> 0:20:07.600 with bond click because they want to see what the 0:20:07.600 --> 0:20:10.640 other dealers are saying. The dealers aren't They're not They're 0:20:10.640 --> 0:20:13.720 not dummies. Uh, they're very very sharp people, of course. 0:20:14.560 --> 0:20:18.239 But the consequence, though, is that increasingly this data is 0:20:18.680 --> 0:20:21.719 becoming more public and you know, bond click is uh 0:20:22.200 --> 0:20:24.879 appears to be leading here, but I suspect I believe 0:20:24.920 --> 0:20:27.719 that there's some others as well. The dealers aren't entirely 0:20:27.720 --> 0:20:30.960 happy about it. So it's not an easy proposition. As 0:20:31.000 --> 0:20:33.120 long as you're speaking about a little bit of history. 0:20:33.520 --> 0:20:39.399 Cannor Fitzgerald ran a open outcry sort of brokered bond 0:20:39.440 --> 0:20:43.879 market and treasuries, and through their E Trade subsidiary since 0:20:43.920 --> 0:20:47.320 spun out, they wanted to get the bonds into an 0:20:47.320 --> 0:20:52.160 electronic trading system and they had had a terribly difficult 0:20:52.240 --> 0:20:56.080 time doing that. The dealers basically boycotted the system for 0:20:56.119 --> 0:20:59.800 a while, but they persevered. They managed to get it done, 0:20:59.840 --> 0:21:03.080 but it's not easy. The big challenge that these systems 0:21:03.160 --> 0:21:06.719 face creating an exchange like system is that when somebody 0:21:06.760 --> 0:21:09.120 needs to trade, they usually need to trade right now, 0:21:09.320 --> 0:21:11.280 and they look at a system they say, wow, that 0:21:11.480 --> 0:21:14.800 is a cracker jack system. That's beautiful. I'd love to 0:21:14.840 --> 0:21:16.920 trade there, but right now, I got to get my 0:21:17.000 --> 0:21:19.720 order done and there's nobody else there, so I'm gonna 0:21:19.760 --> 0:21:22.640 get my order done. And when when that market becomes looking, 0:21:22.720 --> 0:21:24.840 you give me a call and I'll definitely send my 0:21:24.920 --> 0:21:27.720 orders there. So it's a chicken and egg problem here. 0:21:27.760 --> 0:21:30.320 Only the problem is it's not which came first, is 0:21:30.359 --> 0:21:33.679 that neither comes first because people need to get their 0:21:33.720 --> 0:21:37.399 business done and so that's that's the force that keeps 0:21:37.600 --> 0:21:41.159 change from happening too quickly. But On the flip side, 0:21:41.600 --> 0:21:45.439 these electronics systems have vastly decreased the cost of dealing, 0:21:45.920 --> 0:21:48.680 and now you have lots of proprietary traders who are 0:21:48.680 --> 0:21:53.520 willing to deal bonds like they deal stocks. The deal 0:21:53.560 --> 0:21:55.919 odd lots, but they're willing to come back over and 0:21:55.960 --> 0:21:58.679 over again, and so increasingly you're gonna start seeing, and 0:21:58.880 --> 0:22:02.639 we've already seen it, are algorithms used by institutions to 0:22:02.680 --> 0:22:06.000 fill large orders in odd lots, and they'll they'll do 0:22:06.040 --> 0:22:09.760 that because there are dealers who are well dealers are 0:22:09.760 --> 0:22:13.679 proprietary traders, but let's call them proprietary traders are essentially using, 0:22:14.560 --> 0:22:17.439 you know, some crude version of the high frequency trading 0:22:17.480 --> 0:22:20.040 methods that they use in the stock markets to deal. 0:22:20.600 --> 0:22:24.560 We should be clear about what bonds are. So here's 0:22:24.560 --> 0:22:26.880 a fun way of thinking about a bond. People tell 0:22:26.920 --> 0:22:30.320 you that bonds are something special, but from this point 0:22:30.359 --> 0:22:34.359 of view, there perhaps not so special bonds if you 0:22:34.400 --> 0:22:37.120 think about their risk. There are a package of two 0:22:37.119 --> 0:22:41.480 types of risk. There's interest rate risk and it's bundled 0:22:41.480 --> 0:22:44.639 with credit risk. So credit risk is the risk that 0:22:44.720 --> 0:22:47.840 the company that's promised to pay off its bonds goes 0:22:47.880 --> 0:22:50.960 bankrupt and you don't get paid. An interest rate risk 0:22:51.040 --> 0:22:53.119 is the risk that, say you bought a bond and 0:22:53.160 --> 0:22:56.160 then interest rates rise in the price of your bond drops. 0:22:56.160 --> 0:23:00.520 So that's not comfortable. So think about this risk. What 0:23:00.720 --> 0:23:04.120 is there about putting both risks into a single instrument 0:23:04.400 --> 0:23:08.440 and tying them together with an invisible string. The string 0:23:08.560 --> 0:23:11.160 is actually called the bond covenant, the contract that sets 0:23:11.240 --> 0:23:14.600 up the bond. What is there about doing that that 0:23:14.720 --> 0:23:20.000 makes the bond something different from the risk that trades elsewhere. 0:23:20.200 --> 0:23:24.119 So the interest rate risk trades in highly liquid treasury 0:23:24.119 --> 0:23:27.439 bond markets. They are also in the futures markets. They 0:23:27.480 --> 0:23:29.760 are whether they are cash or in the futures. They 0:23:29.760 --> 0:23:33.560 trade in these order driven exchange like systems, and the 0:23:33.760 --> 0:23:36.960 credit risk, as we mentioned earlier, the credit risk of 0:23:37.040 --> 0:23:39.520 bonds is even as much less than the credit risk 0:23:39.640 --> 0:23:43.080 of the associated stocks. So the credit risk is being 0:23:43.320 --> 0:23:47.720