25 July 2012

Bonds, James' Bonds

There's an old (or, perhaps, newish) saw, variously constructed, that goes: "When I die, I want to come back as a bondholder". It was spoken often during the Bailout Debacle. Some, notably Sheila Bair, questioned why it was that only bondholders got off scott free in the bailouts, not counting the firms that were allowed to fail.

As mentioned more than once in this endeavor, banking is a low (at best, more likely no) value activity; merely marrying lenders with borrowers. All of the "innovation" in "products" in the last few decades have served only to increase the size of the diverted money stream from lender to borrower into the pockets of Banksters. Financial service companies don't create value; value is created by smarter production, which financial services doesn't do. Financial services just moves money from Abercrombie to Fitch, for a nice fee.

So, today's Times brings this story laying out the plight of the poor but honest bond trader, soon to be extinct. The piece starts with this:
Bond traders have long defined Wall Street's swagger and, in good years, generated a large share of its profits.

I don't have a cite right to hand (mentioned the number countless times before), but in the run up to the Great Recession, even otherwise assumed-to-be product companies (GE comes to mind) had upwards of 40% of profit from financial services. Again, that profit is just a skim off the lender to borrower money flow. If you read the piece, you'll find that bond trading, outside of Treasuries, has been a dark matter sort of endeavor since time immemorial. Opaque trading means gross profit (in both senses of "gross").

But, a hard rain's gonna fall. The scant changes in process mean that they,
...could drive down the large cut that banks take from most bond trades and make it cheaper for investors to buy and sell bonds.

Poor baby!!

Where does the large vig come from?
Banks have found trading these bonds profitable because they have greater leeway over the pricing than if they traded in a market with transparent prices.

In other words, the big banks keep both lenders and borrowers in the dark, and get fat and happy off the manipulation. But times they are a changin'. The days of trading on the telephone are being replaced by exchange trade, and we all know what that means: computers do the work. Once again, the invasion of flunked out hard science types into commerce. We'll see if they avoid screwing things up the way they've done in the past.
The traders here are mostly educated in math or physics, often outside the United States, and their desks are piled high with textbooks like the "R Graphs Cookbook", for working with obscure computer programming languages.

My impression that sites like R-Bloggers is dominated by the stock hounds looks to be accurate. Pick me! Pick me!

Going forward, bonds will be traded more like, if not in concert with, stocks.
This has resulted in banks shrinking the inventories of bonds they used to have on hand in case a customer wanted, say, a million dollars' worth of 10-year General Motors bonds. Now, those same customers have to look more broadly to find the same quantity, potentially bypassing Wall Street all together.

Not so sure I buy the notion of WS being eliminated, just a different part; more like a NASDAQ for bonds. Play Station and X-Box for millionaires. Old style bond traders, the ones who did deals over the phone, are out of work, and the math-y types are in. From a profitability point of view, automation triumphs. I doubt that bond trader out on the street gets the irony of his solidarity with 19th century New England weavers.

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