How to Lose $667 Million in Bond Trades Without Trying

Updated on

Bond investors can waste a lot of money and not even know it.

They lost about $667 million in the year ended March 31 by paying higher prices for corporate bonds that were available at lower prices elsewhere, according to September research by Larry Harris, a business professor at the University of Southern California.

In most of the deals the investors simply did not know that the lower prices existed because they rely on human traders to tell them the value of bonds at any given moment before they make a trade. (Not to mention the salaries they need to pay those brokers to work the phones to find out who holds what and who might want to sell.)

Working the phones is so last century. In the age of Google, Amazon and high-frequency stock trading, the corporate bond market remains an anachronism. It is long overdue to join modern electronic society, and if it doesn’t, regulators are preparing to step in, something nobody in the market is likely to want.

So far, the Securities and Exchange Commission is only encouraging big bond firms to use electronic marketplaces more frequently so that investors have an easier way to see market prices in real time.

But if that doesn’t work, regulators may take more invasive measures to streamline the playing field and make it cheaper to do business in the $8 trillion market for U.S. company bonds.

Regardless of what the SEC might do, it makes sense for Wall Street banks to work together to find a more efficient way to trade bonds because it may be the best for their bottom lines.

Debt-trading profits at Wall Street’s biggest banks have shrunk in the past few years. They can’t use their own balance sheets to make the bold bets they used to, and that doesn’t always pay off anyway.

They have responded by shrinking their staffs and devoting less money to trading bonds. But by working with competitors and clients to build a comprehensive electronic marketplace for bonds, they could improve their business through efficiency.

Valid reasons exist for why computers don’t yet dominate credit trading. There are thousands of individual bonds governed by different deal documents with different maturities. Some trade infrequently at best, especially because investors often hold onto them until they mature.

But it’s time for a lot less phone and a lot more keyboard, and banks and investors would certainly find their own solution preferable to one imposed by the government.

(Corrects loss figure in second paragraph. For more Market Line insights, see NI MKTLINE.)

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