Sept. 10 (Bloomberg) -- Brian Gevry, chief executive officer of Boyd Watterson Asset Management in Cleveland, has a commitment problem.

Trading in the corporate bond market has fallen a third after averaging $26 billion a day in the first eight months of 2007, according to Federal Reserve data on primary dealers. That means Gevry, who used to flip corporate debt for as much as a $50 profit on a $1,000 issue, has to focus on long-term investments.

``There are no more one-night stands; you have to assume it's a marriage,'' said Gevry, 41, who manages $3 billion in fixed-income assets.

The biggest bond dealers, including JPMorgan Chase & Co., and Citigroup Inc., aren't committing as much cash to boost corporate-bond trading. That's because they're shoring up their capital after the collapse of the subprime-mortgage market spurred about $511.4 billion of writedowns and losses.

While corporate-bond trading is shrinking, average daily trading in government securities has risen to about $584 billion this year from $560 billion in the same period of 2007, Fed data show.

The decline in corporate-debt trading, known in market parlance as illiquidity, is prompting fund managers to demand higher compensation to buy new bonds, driving up borrowing costs for companies, including American Express Co. and Verizon Communications Inc., and reducing returns on existing securities.

`Pay Less'

Yields on investment-grade bonds, those ranked at least Baa3 by Moody's Investors Service and BBB- by Standard & Poor's, reached a record 3.22 percentage points above U.S. Treasuries last week, according to Merrill Lynch & Co.'s U.S. Corporate Master Index. The debt is little changed in 2008, Merrill data show, on pace for the worst year since 1999.

``If a bond is less liquid, you're going to pay less for it, you're going to demand a wider spread, a higher yield,'' said Mark Kiesel, an executive vice president at Pacific Investment Management Co., who oversees $180 billion of corporate debt from Newport Beach, California.

The corporate-bond market is at its most illiquid since the collapse of Long-Term Capital Management a decade ago, said Gevry. Daniel Fuss, vice chairman of Loomis Sayles & Co. in Boston, said he often can't buy corporate debt even when he sees opportunities.

``We're certainly not unwilling. We're unable,'' said Fuss, 74, who co-manages the $17.4 billion Loomis Sayles Bond Fund. ``This year is really something else. I haven't seen it this bad,'' Fuss said in a Bloomberg Television interview.

Less Risk-Taking

About $16.4 billion of corporate bonds have changed hands on average each day this year, 39 percent less than the same period in 2007, according to Fed data.

Before credit markets seized up, investors could count on dealers to act as middlemen, purchasing securities and holding them until a new buyer came along. The yield gap between the bid and asking prices offered by dealers, known as the bid-ask spread, has widened as banks curb risk-taking.

American Express's five-year notes are quoted with a bid-ask spread of as much as 10 basis points, about double that of a year ago, Gevry said. A basis point is 0.01 percentage point. American Express spokeswoman Joanna Lambert declined to comment beyond saying the New York-based company still has access to funding in credit markets.

`Tornado's Hitting'

``The cost of capital for the entire Street has gone up, and it's become just a more-scarce commodity,'' said Frank Berritto, head of global credit sales and trading at Banc of America Securities LLC in New York. ``The tornado's hitting right in the middle of the financial markets, and some dealers are more focused on their own financial health, not necessarily providing liquidity for their clients.''

Berritto says Banc of America has made it a point to ``stay the course'' to expand its share of the new issues market.

The U.S. government placed Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac into a so-called conservatorship on Sept. 7 after the biggest surge in home-loan defaults in at least three decades threatened to topple the two largest mortgage-finance companies.

The bailout is unlikely to improve credit-market liquidity soon, according to Gregory Habeeb, who manages $8.5 billion of bonds at Calvert Asset Management in Bethesda, Maryland.

``There's a lot more positives that have to occur before things start feeling better and there's more liquidity,'' Habeeb said. ``It doesn't just get magically better overnight.''

Top Concern

Two-thirds of U.S. fixed-income investors say a shrinking ability to trade bonds is one of their biggest concerns, according to a survey by Greenwich Associates in July. That's up from less than half a year before, Stamford, Connecticut-based Greenwich said.

So-called multi-sector bond funds, which typically include an allocation to corporate bonds, are down about 1.6 percent this year, on average, compared with a 5.7 percent annual gain the past five years, according to data from Chicago-based Morningstar Inc.

Fund managers ``can't stop the bleeding,'' said Joseph Patterson, president of Los Angeles-based Patterson Capital Corp., which has $1.7 billion of fixed-income assets under management.

Trader Layoffs

Slumping revenue and writedowns have led to layoffs among bond dealers. Half of those working in debt sales, trading or research in New York at the beginning of 2007 won't get a bonus or will have been fired by the end of this year, said Michael Maloney, a financial-industry recruiter with Maloney Inc. in New York.

``There have been layoffs in Wall Street and it's become a morale function, and that affects markets,'' said Fuss of Loomis Sayles. ``No dealers are willing to hold any kind of inventory.''

Spokespeople for Citigroup, JPMorgan, Credit Suisse Group, and Morgan Stanley declined to comment.

Decreased liquidity and higher yields are providing opportunity for managers who can make long-term investments, said Pimco's Kiesel. The 3.22 percentage-point yield spread on investment-grade corporate bonds is more than double the 1.54 percentage points of a year ago, and triple the 97-basis-point spread in September 2006, Merrill Lynch data show.

``Those who do have cash available are going to see some very attractive potential investments over the next year,'' Kiesel said. ``These illiquid markets essentially allow us to set the price.''

AIG Sale

Sales of investment-grade corporate bonds have topped $629 billion so far this year, compared with $726 billion in the same period of last year, according to data compiled by Bloomberg. Issues are about even with the pace of 2006.

To woo investors, borrowers are offering newly issued debt at spreads of as much as a full percentage point above where their existing issues are trading.

American International Group Inc., the U.S. insurer that posted combined losses of more than $18 billion the past three quarters, sold 8.25 percent debt due in 2018 last month at 4.33 percentage points more than Treasuries.

The New York-based insurer's 5.45 percent notes due in 2017 widened 0.6 percentage points to 4.25 percentage points the next day, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Credit Suisse Group, Morgan Stanley, RBS Greenwich Capital and UBS managed the AIG sale. AIG spokesman Nicholas Ashooh declined to comment. Spokespeople for the banks either declined to comment or didn't return calls.

``The fear of impending issuance is causing trading activity to fall'' because new issues are sold at such wide yields they reprice existing debt, said Pimco's Kiesel.

Verizon Spread

Even companies that are weathering the economic slowdown are being penalized in the bond market. While New York-based Verizon reported a 12 percent increase in second-quarter profit, the bid- ask spread on the second-biggest U.S. phone company's debt tripled in the past 15 months to as much as 0.1 percentage point, said Tom Farina, a director at Deutsche Bank's insurance asset management unit.

``Clearly there is a heightened level of economic uncertainty going forward, but I'm not worried about Verizon showing a $10 billion writedown,'' Farina said in an interview from his New York office. His unit manages $150 billion in fixed- income assets.

Verizon spokesman Bob Varettoni declined to comment.

Investors will demand extra yield to buy corporate debt until it becomes easier to trade, said Jason Brady, a fund manager at Thornburg Investment Management in Sante Fe, New Mexico, who helps oversee $5 billion in fixed-income assets.

``Lower liquidity certainly makes the market harder to deal with and therefore less attractive,'' Brady said. ``If I can't buy and sell positions easily, I've got to get paid for that.''

To contact the reporters on this story: Gabrielle Coppola in New York at gcoppola@bloomberg.net; Caroline Salas in New York at csalas1@bloomberg.net

Last Updated: September 10, 2008 11:15 EDT