For those of you involved in the fixed income market, this will be no surprise. On the web, there are hundreds of posts like the one below. I decided to respond on behalf of all responsible members of the fixed income community.
Post:
Looking for some constructive suggestions.I am a fixed income investor. Whole Gamut (Broker CDs, Agency Paper, Corporates, US Treasuries, Mortgage-backed, etc)As any fixed income investor knows, the "spread" in these (mostly) over-the-counter investments can be as much as 3%on any given day. This is probably the last "full price commission" investment type out there.To me its really inconceivable that no one has yet sought to discount these "mark-ups" particularly since the fixed price wall fell on equity trades 30 yrs ago.I've thought about an "exchange" similar to a bulletin board where individuals could post what they have or want,kind of like an eBay of fixed income trading.To those unfamiliar with these mark-ups, it works kind of like this:Investor A owns a $50,000 Freddie Mac Bond with certain interest rate and maturity characteristics. This bond is given a CUSIP number which makes it "unique." This bond (like nearly all others) is held by Investor A's broker in "book entry" within his brokerage account.For whatever reason, Investor A would like to sell this bond. Looking at his statement, Investor A sees that the bond isworth (according to a computer pricing model called a "matrix") 99.25. Thus, Investor A's $50,000 bond is theoretically worth $49,625.Such matrix pricing is used for all sorts of reasons. The IRS accepts it. Margin maintenance is calculated from it.etc. etc.However.here is the rub.When Investor A calls his broker to sell it, his broker will say..."let me get you a bid"Invariably, the borker will get back to Investor A and tell him:The best I can get for you is (for example) 97.50, or $ 48,750.Now..multiply that my the billions of dollars of fixed income securities that trades each day.Where does this "difference" go? It goes to the trading desk of the brokerage firms.So my thought is, how to bypass the trading desk?If a bulletin board was established and Investor A finds Investor B, Investor A would instruct his broker to deliverthe security to Investor B once Investor B delivers the agreed payment amount.Now I'm sure the borkers who read this will flame me.....as this is pure herasy.But you know....it's about time someone told the emperor he's not wearing any clothes.
Reply:
There are a lot of problems with what you suggest, some of which are listed here. Not the least of these problems is your premise that the matrix price for the bond on your account is accurate. They rarely ever are. Don't think of bond pricing like equities. There are roughly 8000 listed equities in the US; maybe half of them trade actively. There are literally millions of bond issues, some of which never trade. If you are really concerned about the bid, ask the broker to offer you the bond, or if not available, something similar. If they are not willing to do it or are unwilling or unable to provide you with a reasonable and understandable explanation, move your account to a firm that will do it. Then you can judge for yourself as to its accuracy. As a person that ran a fixed income trading desk dealing with individual investors at a major firm for many years, that is the information I was more than happy to provide as it showed our desk's professionalism and competitiveness. It is also what I advise my fixed income consulting clients. Finally, the trading desk makes its money on the bid-offer spread, but you are assuming that for bond you sell back to the trading desk, there is a ready buyer on the other side of the trade. That rarely happens, particularly when dealing with individual investors. The bid-offer spread should reflect the amount of risk in any given security. With what is going on in the credit markets, liquidity is lower and bid-offer spreads will be wider to reflect that increased risk as well as other risks.
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This is why I can't take a job in a branch. I can't stand dealing with ignorant, unknowledgeable GUM. I had an "altercation" last week with a broker at my firm who ranted that it was unfair that our firm had trading desks which were profit centers. They want service or order desks. Yet these ignorant asset-gathers don't know what the hell they own! I can't tell you how many calls I get from brokers who have no clue why their preferreds are trading so much lower. The can't figure out why their 4.00% coupon FNMA bond is ha snot been called "on schedule". They can't figure out why yields of credit products don't always move in the same direction as interest rates. They are dumber than dirt!
Now, the brain trust at the retail distribution division of my firm wants to give brokers a system called "Bond Desk" so they can by bonds WITHOUT calling the firm's fixd income area. This way no one will make a spread. Yeah, like every other market maker on the street is non-profit operation.
I heard a gret story two months ago from a broker who had a client who decided to "save money" and bot a bond from a firm famous for mutual funds, but which is now offering bonds. He bought CIT Group bonds which were yielding over 7.50%, but he thought he got a deal on bonds issued by a large bank who's bonds were trading in the high 5.00% area at the time.
A word of advice who those who think the have a better way to invest in fixed income. Before you shoot your mouth off, know of what you speak!
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