Volcker Rule and Muni-Bond Liquidity–back of the envelope opinion.

Volcker Rule and Muni-Bond Liquidity–back of the envelope opinion.

November 22, 2011 Research Insights
Print Friendly
(Last Updated On: January 23, 2017)

Volcker Rule May Adversely Impact Munis

http://www.bondbuyer.com/issues/120_225/volcker-rule-impact-munis-1033412-1.html

The municipal bond market makers are making the case that eliminating prop desks will somehow decrease liquidity and screw up the market in municipal bonds.

Translation:

We love to rake our customers over the coals and take advantage of the fact we get to send liquidity information over to our prop desk. We also love the ability to make money off our cheap access to capital that is backstopped by the American Taxpayer.

The theoretical literature on the subject of bid/ask spreads suggest that the following 3 factors come into play:

  1. dealer order processing costs–the cost of doing business for the market maker
    • this is cheap and will continue to get cheaper as technology improves
  2. dealer inventory costs–dealers have to manage inventory and risk–market makers across many markets seem to do this without a problem.
    • This cost will remain
  3. Adverse information costs–trading is tough when both the buyers and the sellers feel like they are getting f&^#ed.
    • In my mind, this costs would go down a lot if the Volcker Rule were put in place. Having explored the muni market and gotten a taste for how it works–OTC, no transparency, constant fear of prop desk trading, etc.–I am pretty certain that liquidity could actually INCREASE in muni markets if the Volcker Rule were enacted.

On net, the Volcker Rule would simply lower bank profits in the Muni-Market prop game (no more raping customer order flow), but the rule would probably increase transparency and liquidity (customers can worry less about getting raped by prop desk and think more about trading). Overall, the markets and society would be better off. I think.

Regardless, with a ton of lobby power, I’m quite confident that Wall Street banks will continue to be ‘closet hedge funds’ at the detriment of society for a long time.


Note: This site provides NO information on our value investing ETFs or our momentum investing ETFs. Please refer to this site.


Join thousands of other readers and subscribe to our blog.


Please remember that past performance is not an indicator of future results. Please read our full disclosures. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.


Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.