Why it is so expensive to trade muni bonds?

July 16, 2014

Why is it so expensive to trade municipal bonds? We finally have some answers from a long awaited MSRB report on trading in the opaque muni bond market. The study was conducted by former SEC Director of Enforcement Erik Sirri. It maps where bonds go before they settle into retail customer accounts. Every time the bonds change hands, the price is marked higher. In the dark muni market, nobody sees this happening.

Sirri’s study analyzed 43 million trades between 2003 and 2010. Over 73 percent of the muni trades were for less than $50,000.

muni trades

A trade begins when a dealer buys bonds from a retail customer, and then either sells those to another retail customer or trades them to a dealer (who then sells them to a customer). This “inter-dealer” trading can happen 2-10 times before a bond lands in a customer account. The report refers to these as “chains” of trades. You can see how the bonds are marked up between the chains here:

Transaction chain

These trades often happen within the time frame of one day:

Muni trades

In fact, almost half of the trades happen within one minute:

Muni trades

Small trades cost more than big trades. As the bonds go through a number of dealers, the price goes up. This chart expresses the cost differential in basis points (a basis point is a 100th of a percent, so 200 bp = 2 percent):

Muni trades

The cost of doing a trade goes up until the bonds are about 10 days old, and then decline in price. The bonds have become stale inventory:

Muni trades

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