MuniLand

Municipal bond trading volumes are on a downward march. The Municipal Securities Rulemaking Board (MSRB), which oversees muniland, publishes trade statistics on its website. You can see on the chart below, which shows daily trade volumes, how “customer bought” trades especially have been trending down. These are trades done by retail and institutional clients to acquire bonds.

“Customer sold” trades, which generally represent funds or brokers selling bonds out of client accounts to be replaced with other bonds, have been relatively steady. Bonds are sold to raise cash and to move assets to other classes. Interdealer trades are done between dealers to transfer bonds that are sold onto clients who are not dealers (think retail and institutional investors).

There are several reasons for declining trade volumes, but foremost is the very low level of yields on municipal bonds today. Taylor Riggs of the Bond Buyer, who reports dealer trading desk activity, tweeted this on Tuesday:

#muniland slow again as little direction stalls the market. hard to trade munis with yields so low… bit.ly/RHT7eK

— Taylor Riggs (@TaylorRiggs_BB) September 11, 2012

With very low yields there is not much “spread” — the difference between the bid and offer price — for dealers to capture. The market effectively becomes more sluggish because there is less incentive for brokers and dealers to search out trades. Investors would usually prefer to wait on the sidelines for higher yields before getting back in the market.

Flash Player 9 or higher is required to view the chart
Click here to download Flash Player now

// View the full MUB chart.

A small but growing corner of muniland consists of municipal bond exchange traded funds (ETFs). I know very little about these products and asked Matt Tucker, a managing director on BlackRock’s fixed income portfolio management team, to write a short introduction to the product.

ETFs: The new way to access the municipal bond market

Traditionally, the only two options available for those who wanted to invest in the municipal bond market were through mutual funds or laddered bond portfolios. In the past five years, though, exchange traded funds (ETFs) have come on to the scene. They provide a combination of diversification, index performance and exchange liquidity, making them a compelling addition to anyone’s municipal bond investments.

Tom Keene of Bloomberg did a fantastic interview with legendary municipal bond broker James Lebenthal last week. It’s worth a listen, but a big, unanswered question from their discussion was how the municipal bond market could become more liquid for retail investors. It was rather surprising to hear Lebenthal stumped for an answer, since Wall Street’s largest banks have been whining that if the proposed Volcker Rule were implemented, it would kill the market liquidity they provide. The rule is still being fine-tuned by federal agencies, but at its core it will ban speculative securities trading by commercial banks. However, the Volcker Rule will allow commercial banks to continue the traditional securities activities of market making and underwriting fixed income.

Jim Lebenthal and Paul Volcker are the grand old warhorses of the U.S. financial system. They have worked in and overseen banks and securities dealers for decades. They also both worked for most of their careers under Glass-Steagall, the federal banking law that separated commercial banking and securities operations, until it was repealed in 1999. Both men have implied in letters and interviews that the current structure of the market is not optimal. The Volcker Rule is a partial return to the days of Glass-Steagall.

As Volcker points out in his comment letter to the federal agencies that will implement his eponymous rule, the “liquidity” that banks claim their speculative trading adds to markets is not an essential part of financial services: