Speaker 1: Welcome to this week's Odd Blots. I'm Tracy Alloway, Executive
Speaker 1: editor of Bloomberg Markets, and I'm Joe Why isn't the
Speaker 1: all managing editor of Bloomberg Markets and the co host
Speaker 1: of What You Missed. It's Monday, November six, and I
Speaker 1: want to talk about bonds, corporate bonds to be specific.
Speaker 1: So I'm really excited about this episode because I basically
Speaker 1: know nothing about bonds. I know that when bond prices
Speaker 1: go down, yields go up and vice versa. And I
Speaker 1: know sometimes credit quality as a factor in interest rates
Speaker 1: affect bonds, But beyond that, I'm a complete novice and
Speaker 1: I can't wait to just sit and learn from this discussion.
Speaker 1: All Right, but you know, bonds are the things that
Speaker 1: companies sell to investors to fund their businesses, right this
Speaker 1: I also know. Do you know it's an eight trillion
Speaker 1: dollar market in the U S Alone? I knew it
Speaker 1: was gigantic. Do you know how bonds trade? I knew
Speaker 1: a little bit, but mostly what I know is what
Speaker 1: you told me the other day. Okay, so what I
Speaker 1: told Joe the other day is that bonds are traded
Speaker 1: in a really old fashioned way. Still, So when you
Speaker 1: think of buying and selling stocks, for instance, it's usually
Speaker 1: pretty easy to do it. Investors large and small can
Speaker 1: do it just with the click of a button. When
Speaker 1: it comes to buying and selling bonds, it's much more difficult.
Speaker 1: You actually have to pick up the phone, call a
Speaker 1: dealer at a big dealer bank, figure out price size,
Speaker 1: and do the transaction. That way. It's much less electronified.
Speaker 1: And part of the issue too, is that everybody knows
Speaker 1: what a share of Microsoft is. There's one share of
Speaker 1: Microsoft common stock. But on the other hand, a company
Speaker 1: like Microsoft could have numerous different flavors of bonds, different years,
Speaker 1: when they mature and stuff like that. So there isn't
Speaker 1: like a single Microsoft bond that you could just trade.
Speaker 1: It makes trading much much more complicated. But there are
Speaker 1: other factors underlying the bond markets resistance to change, and
Speaker 1: we're going to talk about those factors today. And here
Speaker 1: to talk with us about them is Chris White, a
Speaker 1: former vice president at Goldman Sachs and someone who is
Speaker 1: we're about to learn, has had a lot of firsthand
Speaker 1: experience with the bond market and forcing through change on
Speaker 1: the market, trying to bring it into the modern era. Exactly. So, Joe,
Speaker 1: I want you to sit back, relax, and try to
Speaker 1: learn something. So Chris, tell us about your background in
Speaker 1: this space. So I've been working in electronic fixed income
Speaker 1: business development for about thirteen years. I used to be
Speaker 1: a bond salesman and then I was an equity arbitrage trader.
Speaker 1: For the past ten years, I've been working on the
Speaker 1: dealer side. I would say, Um, the general responsibilities for
Speaker 1: my role were to help the credit market making businesses modernized.
Speaker 1: So I did that for Barkley's and and Lehman Brothers
Speaker 1: when we integrated, and then Goldman for the past five years,
Speaker 1: and I just recently left. So let's talk about modernizing
Speaker 1: the corporate bond market. Walk us through the way that
Speaker 1: the bond market trades now or has traded historically. Is
Speaker 1: it fair to call it old fashioned? Uh? Oh, it's
Speaker 1: just it's it's set a stage that I think all
Speaker 1: markets go through. There are three major stages to markets.
Speaker 1: The first stage is um a physical market in which
Speaker 1: human beings are directly interacting with each other in order
Speaker 1: for the market to work. And then what we're seeing
Speaker 1: in a lot of financial markets is what I call
Speaker 1: the hybrid stage. Which is human beings interacting with each
Speaker 1: other through screens. And that's really where some of or
Speaker 1: or a lot of the UM fixed income markets are
Speaker 1: going right now. And then you have the final stage
Speaker 1: that we're seeing in UM more electronically traded markets. I
Speaker 1: call them automated markets, where you're really having algorithms interact
Speaker 1: with algorithms, and that's where you get high frequency trading
Speaker 1: in ffcs and rates and futures. But where we are
Speaker 1: from the bond market standpoint is, I think we're really
Speaker 1: transitioning from stage one to stage two. So something like
Speaker 1: the stock market would be probably at stage three in
Speaker 1: your mind. UM, there are areas of the stock market
Speaker 1: that's at stage three. And I think that what gets
Speaker 1: confusing for a lot of people king at markets is
Speaker 1: they tend to look at them with a sort of
Speaker 1: a one size fits all and an inevitability around where
Speaker 1: the markets are going. That I would say, I call
Speaker 1: it sort of like a sky net sort of view
Speaker 1: that eventually will the machines will run everything. And UM,
Speaker 1: I find this fascinating because we have I think a
Speaker 1: great case study in the Internet, and we look at
Speaker 1: the Internet right now and we see that not everything
Speaker 1: has gone to a fully automated solution. It's not because
Speaker 1: of regulation. It's not because of some sort of laws
Speaker 1: around it, except for I believe the science around how
Speaker 1: markets work all right now on bonds. Even if you
Speaker 1: don't think the market is old fashioned, it's difficult to
Speaker 1: argue that it's not at a later stage in its
Speaker 1: development than the stock market in terms of electronification. Why
Speaker 1: is that, Well, I believe in a theory around size.
Speaker 1: I think that size has a really huge impact in
Speaker 1: the way systems work. And the best analogy that I
Speaker 1: can make is um in the island of Manhattan and
Speaker 1: eighteen fifty you had about half a million people living here,
Speaker 1: but over the next fifty years the population tripled, so
Speaker 1: by the end of the nineteenth century you had one
Speaker 1: and a half million people living on the same space,
Speaker 1: and that necessitated the development of a subway system. So
Speaker 1: in eighteen fifty we don't need a subway system, but
Speaker 1: you can see, with more people in a condensed space,
Speaker 1: you need a piece of architecture that's going to allow
Speaker 1: the city to function more optimally. UM what we've seen
Speaker 1: in the equity markets, FX markets, futures markets has been
Speaker 1: massive growth in terms of the outstanding size of the
Speaker 1: market necessitating the delivery of architecture in the form of technology.
Speaker 1: We have not seen that growth until the past really
Speaker 1: six or seven years post two thousand and eight in
Speaker 1: the bond market. And so now what you're getting is
Speaker 1: a market that's exploded in size without modernizing. Now, this
Speaker 1: brings us seamlessly to our next point, which is that
Speaker 1: in addition to worries over the way bonds have historically
Speaker 1: been traded, that has fed into worries about liquidity in
Speaker 1: the market. And this is basically the ease of trading bonds.
Speaker 1: And the idea here is that liquidity is low. You
Speaker 1: can't buy or sell bonds without heavily impacting the price.
Speaker 1: And that could be a problem because we've seen the
Speaker 1: market explode in size and so many people buy these things.
Speaker 1: If everyone decides to head for the exits all at once,
Speaker 1: we could have a liquidity crisis. Basically, I think that
Speaker 1: there's a huge misunderstanding around what liquidity really is. I
Speaker 1: think this misunderstanding is pervasive across almost all conversations that
Speaker 1: I hear about it. Um It starts really at the beginning,
Speaker 1: what do you believe liquidity is and liquidity is subjective.
Speaker 1: It's like beauty, so you can't really define it, though
Speaker 1: I think there are some metrics we could probably use
Speaker 1: UM where you could at least get close to it.
Speaker 1: Where I think the liquidity debate starts is do you
Speaker 1: believe that liquidity is a naturally occurring resource that can
Speaker 1: be harvested if you network a market, or do you
Speaker 1: believe that liquidity is an unnatural resource and a service
Speaker 1: that must be provided by someone. So basically the idea
Speaker 1: of whether or not you should pay for your liquidity, well,
Speaker 1: if you think it's a natural resource that you can
Speaker 1: just harvest if you network the market, then you're going
Speaker 1: to believe that if you use technology in the right way,
Speaker 1: liquidity will just show up and UM. What's what I
Speaker 1: find fascinating about this is that theory has never been
Speaker 1: proven in not only UM, any of the financial markets.
Speaker 1: It's never been proven in any market ever in the
Speaker 1: history of markets. I recently was participating in a discussion
Speaker 1: around this and somebody said, when talking about liquidity that
Speaker 1: the bond market, once technology hits, is going to function
Speaker 1: more like Uber. And what I found really interesting about
Speaker 1: that is Uber doesn't eliminate the you know, necessity for
Speaker 1: the person wanting transportation to pay for the ride. It
Speaker 1: just makes it easier. So we're not uberizing any of
Speaker 1: these markets per se, and and and moving to a
Speaker 1: world in which you don't need a transportation provider because hey,
Speaker 1: I just am able to communicate with other people who
Speaker 1: happen to be going the same way as me, and
Speaker 1: therefore my transportation needs are met. I think the perfect
Speaker 1: analogy for the networked liquidity theory is what you're really
Speaker 1: saying is, um, if I had to go somewhere, I'm
Speaker 1: going to rely on hitchhiking as the vehicle. What do
Speaker 1: you think about liquidity concerns in general? Though? Do you
Speaker 1: fear that sort of worst case scenario where interest rate
Speaker 1: rise and everyone tries to head for the exits at
Speaker 1: the same time? Not necessarily that's actually the heart effect
Speaker 1: has never been proven in markets. I think that what
Speaker 1: we're really dealing with, and with most markets deal with,
Speaker 1: is a perception problem, and and perception has led to
Speaker 1: stampedes before, so um, we haven't put in the fixed
Speaker 1: income markets. I think things that would reduce the perception
Speaker 1: that there could be a massive run for the exits.
Speaker 1: One of the things that was discussed recently and dismissed
Speaker 1: by a lot of large asset managers is a provision
Speaker 1: that would be put in where they would have to
Speaker 1: hold extra cash. And what that would do is if
Speaker 1: they had a lot of redemptions people wanting to get
Speaker 1: out of their funds, instead of them having to actually
Speaker 1: sell bonds and create this mass effect that everyone's worried about,
Speaker 1: they could just respond to those redemptions with cash on hand. Right. Um,
Speaker 1: but that hasn't been enacted as a policy. Um, but
Speaker 1: I think just putting something in like that may just
Speaker 1: um make people feel more at ease that this theory
Speaker 1: might not come to pass. Now, when you were at Goldman,
Speaker 1: you started something in the bond market space called G Sessions,
Speaker 1: an electronic bond trading platform. Nowadays we've seen dozens of
Speaker 1: these things come to market. Bloomberg also has electronic bond
Speaker 1: trading capabilities. What was the idea behind it and would
Speaker 1: you call it successful? Yeah? Well, the the G Sessions platform, Um,
Speaker 1: you know, I thought about it and and created a
Speaker 1: Goldman because I've been looking at the liquidity issue in
Speaker 1: the bond market for quite some time. I know it's
Speaker 1: in vogue now. But UM back in two thousand and nine,
Speaker 1: I was really looking at this and I stumbled across
Speaker 1: UM a piece of market structure history. When they were
Speaker 1: dealing with a similar liquidity issue in equities, there was
Speaker 1: a really fantastic platform created. It was the first dark pool,
Speaker 1: something called I T G posit And what it, what
Speaker 1: basically G sessions comes from, is that philosophy. And what
Speaker 1: the philosophy is is that you can create a more
Speaker 1: efficient market if you actually slow things down. And it's
Speaker 1: something called periodic trading or point in time trading. And
Speaker 1: we see this a lot in systems that are only
Speaker 1: in financial markets. We also see it in systems outside
Speaker 1: of financial markets. If if you've ever used the the
Speaker 1: guilt shopping site, Tracy, I don't know if you ever have.
Speaker 1: Unfortunately for my credit card balance I have, right, So
Speaker 1: does that site work? That site works. They have periodic
Speaker 1: sales of designers and you kind of get an advanced
Speaker 1: notice of what sales are coming on and then you
Speaker 1: can be there when the sale happens and hopefully snap
Speaker 1: up a pair of shoes or something. Yeah or ten. Uh.
Speaker 1: So you know guilt if you know the origin of it,
Speaker 1: it started in response to the two thousand and eight
Speaker 1: sort of economic crisis where you had all these high
Speaker 1: end designers who had a tremendous amount of inventory. And
Speaker 1: as you know, with fashion, you're always building new things
Speaker 1: that you want people to buy. So if your old
Speaker 1: line is sitting on the shelves, how do you get
Speaker 1: rid of it? But how did you get rid of
Speaker 1: it in a way that doesn't hurt your brand? So
Speaker 1: Guilt really addressed that with a periodic flash sale that
Speaker 1: preserved the brand, made it very lucrative not only for
Speaker 1: the people looking to get these these items, but also
Speaker 1: made it really lucrative for the designers themselves because they
Speaker 1: were able to control the amount of inventory that they're
Speaker 1: selling in these slash cells each time. UM. I say
Speaker 1: that to say that there is a science behind how
Speaker 1: markets work, and you can see it both in financial
Speaker 1: markets and outside of them. So with g sessions, we
Speaker 1: were trying to harness that science, UM by basically creating
Speaker 1: what's called temporal consolidation, or that's a fancy way of
Speaker 1: saying everybody doing everything at the same time. There could
Speaker 1: be benefits to trading, both on the people seeking liquidity
Speaker 1: and us as a liquidity provider, right, So I remember
Speaker 1: you would essentially have sort of sales of bonds that
Speaker 1: were pre advertised, and then people would know what was
Speaker 1: going to kind of come on the platform and they
Speaker 1: could be there at the same time, and you create
Speaker 1: a sort of point of liquidity. However, Goldman kind of
Speaker 1: backed away from the platform, right. Can you kind of
Speaker 1: explain what happened there and maybe walk us through how
Speaker 1: investment banks are dealing with changes to the bond market
Speaker 1: in general. You described it pretty well. I mean, I
Speaker 1: think it's we could call it the guilt for behind trading,
Speaker 1: where we we would pre announce when a bond was
Speaker 1: going to trade and then see how many buyers and
Speaker 1: sellers we could get to participate in the session, what
Speaker 1: we were calling it. I think the the issue that
Speaker 1: UM Goldman was having with g sessions as a platform
Speaker 1: in general was actually pretty commonplace, you know, for many
Speaker 1: of the investment banks, especially the ones that are well
Speaker 1: established and very successful like Goldman, where the benefits associated
Speaker 1: with change do not necessarily outweigh In fact, in no
Speaker 1: way outweigh the benefits associated with remaining the status quo
Speaker 1: on big successful businesses. So I felt as the inventor
Speaker 1: of the system. I was constantly having to defend the
Speaker 1: purpose of the system to people who had built careers
Speaker 1: and had made far more money than the system was making. UM,
Speaker 1: which is totally understandable. I'd say that the best way
Speaker 1: I can describe what happened is similar to what happened
Speaker 1: to Kodak when the digital camera was introduced. Um, they
Speaker 1: still hang hung on to a business model in which
Speaker 1: they would be processed film. However, Kodak now doesn't exist
Speaker 1: anymore because they didn't see where the world was going.
Speaker 1: So this is the idea that banks have bond traders
Speaker 1: who make a lot of money for the bank by
Speaker 1: essentially acting as middlemen for bond trades. So why would
Speaker 1: they want to give up that business? Well, I think that, Um,
Speaker 1: it's the it's it's really I think an easier way
Speaker 1: for people to think about markets is not to think
Speaker 1: of markets as systems of information, but to think of
Speaker 1: markets as cultural institutions. And they become cultural institutions because
Speaker 1: behaviors are institutionalized by the repetitive nature of actions. So
Speaker 1: then you start to believe that the market works this way,
Speaker 1: and that's your belief system around how things should go.
Speaker 1: And so the belief system for many of the existing
Speaker 1: bond traders is that the way that this market functions
Speaker 1: best is if UM for every trade, I'm on the
Speaker 1: phone with a customer and I'm providing them liquidity directly
Speaker 1: in a bilateral fashion. The problem, now, though, to go
Speaker 1: back to what we're talking about earlier, is that that
Speaker 1: sort of um, you know, cultural belief system can service
Speaker 1: a market that's maybe two trillion to three trillion in size,
Speaker 1: which is where we were back in two thousand and three.
Speaker 1: This market today is over eight trillion in size and
Speaker 1: screaming towards nine trillion. So this sort of old school
Speaker 1: I need to be on the phone all the time
Speaker 1: for every single trade simply cannot service this market the
Speaker 1: same way that a horse and carriage in Manhattan in
Speaker 1: eight was not the preferred method of transportation because there
Speaker 1: were just too many people in the city and you
Speaker 1: couldn't move around. Right, We're going to wrap it up slowly,
Speaker 1: but we've seen a lot of banks, Goldman included, claim
Speaker 1: that there are technology companies. Now we've had Lloyd Blank
Speaker 1: find stand up multiple times and say we're a technology
Speaker 1: firm coming from inside the bank and being on the
Speaker 1: forefront of some of its technological endeavors. What do you
Speaker 1: think about that? I think it's very interesting branding. I mean,
Speaker 1: there's some of these businesses are are making so much
Speaker 1: more have made so much money historically that even the
Speaker 1: best case scenario around a technology solution would never equal
Speaker 1: you know, what these businesses make year over year. So
Speaker 1: I think that a lot of the saber rattling, not
Speaker 1: just from Goldman but from other dealers around being a
Speaker 1: technology company are really designed to make investors feel more
Speaker 1: comfortable with the longer term strategy. Hey, we're not big
Speaker 1: risk takers. We're trying to actually develop solutions that have
Speaker 1: higher margins and are more sustainable. I mean, somebody who's
Speaker 1: actually acting on that instead of just talking about is
Speaker 1: actually eye Cap. Ey Cap as an inter dealer broker.
Speaker 1: They they their business is basically to broker trades between banks,
Speaker 1: and a lot of that business has been going the
Speaker 1: way of electronic systems. An eye Cap has made a
Speaker 1: very large bet that voice negotiation of trades between banks
Speaker 1: is going to become extinct. That's why they've sold it
Speaker 1: to toll It's their arrival and they're putting all of
Speaker 1: their chips on the table and betting on actually electronic
Speaker 1: systems being the future of of d eler to dealer trading.
Speaker 1: All right, speaking of cultural and technological change, Chris, you
Speaker 1: once told me something really interesting about meetings at Goldman. Well, yeah,
Speaker 1: I think it was. What we were talking about was
Speaker 1: just basically how banks were handling innovation. And I think
Speaker 1: what my response to you was, Eventually I stopped calling
Speaker 1: meetings because in terms of talking about innovation and resources
Speaker 1: and strategic planning, I could never go into a meeting
Speaker 1: without knowing exactly what everyone in the meeting was supposed
Speaker 1: to say. And I was, you know, pretty much directed
Speaker 1: to behave this way, which was before you go into
Speaker 1: a meeting, make sure you have individual bilateral meetings with
Speaker 1: every person who's coming into that meeting beforehand. And so
Speaker 1: it became really difficult, I would say, to be effective
Speaker 1: in a meeting, because I don't think that they were
Speaker 1: designed to get anything done. They were really designed to
Speaker 1: make sure that, um everyone was protecting their own interests
Speaker 1: and doing it in a formal way. Did anyone notice
Speaker 1: that you weren't calling any meetings? I think they were
Speaker 1: kind of relieved that I wasn't they didn't want to say, hey,
Speaker 1: I want to have another meeting with you, mainly because
Speaker 1: you know, think of what my topic is in a meeting.
Speaker 1: I'm talking about change. I'm talking about something that may
Speaker 1: make someone uncomfortable, something that they may not understand on
Speaker 1: the surface. And I think that some of the best
Speaker 1: advice I ever got from Goldman was when I first
Speaker 1: arrived Um, somebody very senior took me aside and they said,
Speaker 1: there are two minute guys, two year guys, and ten
Speaker 1: year guys. The two minute guys are people who have
Speaker 1: made so much money that they could retire in two
Speaker 1: minutes and it wouldn't make a difference to their bottom line.
Speaker 1: The ten year guys are the people who know that
Speaker 1: they need to make a career out of the future
Speaker 1: of this business, and therefore they're going to be very
Speaker 1: invested in you. But it's the two year guys. It's
Speaker 1: the people who in two years want to retire are
Speaker 1: going to be inertia for you. They're not going to
Speaker 1: want to see innovation because they want to see if
Speaker 1: they can clip a few more coupons before the music stops.
Speaker 1: It's a good way of putting it. Well. It was
Speaker 1: prophetic in terms of the advice it was. It was
Speaker 1: really helpful for me figuring out where do you belong
Speaker 1: two minutes, two years, or ten years, and then I
Speaker 1: was I was able to navigate a little bit easier
Speaker 1: in that way. All right. Since leaving Goldman, Chris White
Speaker 1: has founded his own company, Viable Markets, which is helping many,
Speaker 1: many different types of financial institutions to modernize their fixed
Speaker 1: income structures. Chris, thank you so much for being here,
Speaker 1: my pleasure, Tracy. Alright, Joe, we just heard a whole
Speaker 1: bunch of interesting stuff. What did you learn that was
Speaker 1: totally fascinated. I'm just amazed at the extent of the
Speaker 1: complications of this problem and how difficult it's going to
Speaker 1: be to solve. Also, I'm never going to take another
Speaker 1: meeting again. All right, thanks everyone for listening. I'm Tracy Alloway.
Speaker 1: You can follow me at Tracy Alloway on Twitter, and
Speaker 1: I'm Joe Why is It Thought? Follow me at the
Speaker 1: Stalwart on Twitter, and please join us next week for
Speaker 1: another episode of Odd Lots.