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An Answer To Bond Market Illiquidity

May 02, 2018 4:54 PM ET9 Comments
Kurt Dew profile picture
Kurt Dew


  • The market for short-term credit has been largely reduced to a single maturity – overnight.
  • Uncomfortable, since the reason is loss of faith in the safety of major banks.
  • Commercial banks are in eclipse, being replaced by shadow banks.
  • But it is possible for finance to rise from the ashes – to turn this crisis to our advantage.
  • Beginning by dumping the bond market.

"I thought I knew you, What did I know? You don't look diff'rent, but you have changed. I'm looking through you. You're not the same."

- The Beatles.

Suddenly, it’s all overnight, all the time! That’s the new reality of the money markets. Longer-dated short-term credit markets have mostly dried up – producing the side effect that LIBOR, the short-term rate that’s still the pricing basis of the world’s largest financial futures market, as well as several hundred trillion in credit assets and over-the-counter derivatives, is a myth. And the government, observing the move among financial institutions from LIBOR to overnight, has accelerated the movement to overnight by proposing to replace LIBOR with the Secured Overnight Financing Rate (SOFR, an overnight repo rate of governmental construction.)

But LIBOR's use as a pricing index rolls on. Financiers don’t seem to mind that the daily-reported number is imaginary. There have been more LIBOR sightings than sightings of aliens, Elvis, and Sasquatch combined. The continued routine use of LIBOR is a tribute to the human imagination.

However, in banking and regulatory circles, there is much hand-wringing since the spot short-term money markets dried up. The end of a way of life, really. But I have reconsidered the new overnight world.

Good news! If the markets embrace overnight funding on a permanent basis, this new overnightedness, to my amazement, produces a baseline for credit market reform and renewal.

For example, the old-fashioned, complicated, obscure, information-intensive issuance of corporate bonds can be replaced. Instead of the complex current bond market – a bazillion, obscure, illiquid bonds that are the play-toys of hedge funds and bond salespersons – the bond market could be replaced by a liquid, buyer-friendly, market-priced, bond market – consisting of only a few active, market-priced, user-friendly issues.

The bad news: there seems to

This article was written by

Kurt Dew profile picture
My primary interest is financial market structure. I write about market platforms, index instruments, and exchange management firms primarily. I was a member of the team that introduced index trading at the CME. Later, I pioneered the secondary market trading of OTC interest rate swaps.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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