Spreads have blown out in corporate bond markets… (thanks to EconompicData for the nice graph)…
The big bank/broker dealers previously had used their giant balance sheets to dominate trading in these markets… think Citi, Morgan Stanley, Goldman, Merrill…
Since the beginning of the Credit Crisis in August 2007 these dealers have had their position as principal market makers decimated… their balance sheets have imploded…
Previously these firms would use their access to cheap funding at the Federal Reserve to stand as the buyer in fixed income securities transactions… so, for example, Citi would buy unwanted bonds from Pimco and either turn around and find another buyer and make a “spread” (the difference between the transaction prices)… or Citi would use it’s capital to hold the bonds in inventory and make a spread between what the bonds were paying in interest and their cost of funds…(or often the dealer would turn to an interdealer broker and trade the bonds away to another dealer).
It’s a new time in fixed income markets…
Bloomberg writes today about all these new boutique trading shops opening…
~~~~ “I don’t mean to dance on anybody’s graves here, but it’s just this incredible opportunity to reassemble a securities firm that does business the right way,” said Lee Fensterstock, chief executive officer of one of the firms, Broadpoint Securities Group Inc. in New York. “That business is going to lead with brain as opposed to capital. We’re not planning to run big balance sheets or big leveraged positions.” ~~~~
What makes it possible for these firms to sprout up?
>> Bloomberg terminals – the circulatory system of fixed income markets
>> ATS – aggregating trading platforms like Tradeweb and MarketAxess
>> Market data systems like the new CDS data portal at Markit
>> Standards for trading :::: FIX Protocol :::::
>> New regulations for credit rating agencies opening issuer information flows
What will these firms do for the markets?
Hopefully the brainpower and competitive ambitions of the traders and salesmen in these small firms will help liquefy a very concentrated, unstable market… our previous market structure of having a handful of “too big too fail” bank broker/dealers dominate fixed income markets was a ripe setting for the black swan…
As the Bloomberg article points out many of these new small shops will fail… access to funding will be critical for them to thrive… but their emergence is one of the most positive signs of the return of financial market stability and demonstrates how markets inherently create their own stability…
Break up the insolvent, large banks and let the ambitions and talents of market players rebuild our great capital system from the bottom up…
Market structure is reforming itself… we can see it as spreads widen and tighten… the butterfly wings of market movement…
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