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Matt Levine

Banks Wanted to Keep the CDS Market to Themselves

An effort to derail a trading exchange costs firms $1.87 billion.

The job of a dealer in financial markets is to buy low and sell high. Of course that's the job of an investor too. That's the obvious, only job. What distinguishes dealers from investors is, loosely speaking, that dealers are not making their buying-and-selling decisions based on some analysis of the value of what they're buying and selling, but rather based on information about who else wants to buy and sell, and at what price. Their job is to know their customers, not their securities. And the information they have about potential customers is pretty much the value that dealers add. It's what they get paid for: Sellers come to dealers to find buyers, and buyers come to find sellers. So the dealers try to make sure that they have information that other people -- like the customers -- don't have.

This explains like half of the scandals in modern finance. We talked earlier this week about the former Nomura mortgage bond traders who were accused of going to baroque and possibly illegal extremes to hide information from customers. In the mortgage-backed securities market, trades were not publicly reported, and the only way for customers to find out the price of a bond was to ask a dealer. The Nomura traders were accused of lying to the customers about the trades they were doing, to obscure the market price from the customers.  In other markets, trades are publicly reported, but dealers can still make nefarious use of customer order information. That's sort of what the foreign exchange fixing scandal looks like: Customers gave orders to dealers, and dealers used those orders to manipulate prices in ways that the customers did not expect.  In the equity market, both trade and order information are public: Anyone can see how many buyers and sellers there are for a stock, and at what price. But electronic market makers race to see it faster, so they can make a fraction of a penny on each trade, and the exact mechanics of how they do that are subject to endless controversy. Meanwhile, spoofers are trying to deceive market makers about the supply and demand for stocks, so they can profit from the market makers' incorrect information.