Greenspan’s Enlightenment Should Be Extended to Bond Trading

In heart wrenching Congressional testimony today, former Federal Reserve Chairman Greenspan called into question that the beliefs he held for the last 40 years might have been flawed. The free market alone does not cure all ills. The troubled former Fed chairman implied that cleaning up after excesses is not always a superior substitute for regulation. CNBC said that Greenspan came up short of saying that he held interest rates too low for too long.

When the press highlights the need for regulation, they focus on catastrophic failures like subprime and Alt-A mortgages, investment bank leverage, credit default swamps (CDS), securitizations (MBS and CDO), and of course the ratings agencies. All this makes for great sensationalism, but I would like to focus on the more sedate world of corporate bonds.

Now is the time when retail investors should be focused on income, and the wild price swings in bonds present great opportunities. Unfortunately, this world remains very opaque. Bonds that trade flat (similar to preferreds) on the NYSE are the most retail friendly. However, most bonds trade by CUSIP Code, based on a percentage of par plus accrued interest. Without a central clearing house or exchange, the retail investor is left to choose from the dealer inventories linked to their broker.

FINRA.org provides a good place to start your bonds search. You can search by company, ratings, yield and maturity. But, bid-ask spreads vary and your broker might not match the pricing shown on FINRA. The price and yield charts are especially helpful. I have not found bond charting available on any of the brokerage sites, although some brokerage sites provide a table of recent trades.

Given Greenspan’s new focus on visibility, the SEC should provide links to all fixed income prospectuses that are actively traded. There are a great deal of fixed income products that have bond sounding titles, but are really complex structured products. The lesson of auction rate securities (ARS) is know what you are buying – trust no one. FINRA and many brokers provide scant detail beyond call dates and whether the interest rate is fixed or variable. To find the index for variable rates, you have to go to the prospectus. Some bonds even contain ticking time bombs such as forced conversions to common stock.

I imagine that bond trading in an opaque world is one of few very profitable venues open to broker/dealers these days, and they would be reluctant to give it up. John Thain talked about making the NYSE the center of bond trading before moving on to Merrill Lynch (MER), but nothing came of it.

I propose creating a series of standard fixed and variable rate perpetual bonds that companies can incrementally sell and redeem at a discount or premium depending on market conditions. If the standard fixed rate is 5% and variable rate is LIBOR plus 2%, the actual rate would be based on a percentage of par. Par values should be standardized at $1,000 for simplicity. Interest should be paid quarterly so the standard bonds could trade flat.

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