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Subject:  Re: Brokers, Cribbage, & Mosquitoes Date:  7/7/2006  1:27 PM
Author:  imdajunkman Number:  17410 of 36785

So do you agree with the statement that I was given, that the TIPS market is very illiquid, and to have to wait a few hours for a market order execution is not unusual? Since institutions probably buy in huge quantities, but not all that frequently, it seems plausible, if not likely.


I know nothing about TIPS. Loki is the resident expert. But I do know a tiny bit about bond trading, and I'd say that your having to wait for an execution --or anyone having to wait for a bond execution-- is total bullsh*t. The desk to which you submitted your order was deliberately sitting on the order, waiting to see if they could get a better offer from someone else.

I've had a similar situation happen a bunch of times. I'd write the order and then wouldn't get a prompt fill. So I'd attempt to cancel. Immediately, my order was executed. Or I'd write the order and wouldn't get a fill. Then at the end of the day, I'd finally get message: "Order canceled". Or I'd write the order and they'd came back to me with a message: "Price changed. Do you want to accept?"

The variations are endless, but they all amount to the same thing. The market is illiquid, as in there aren't many trades happening. But the desk holding the bonds and the next-level-up intermediary (which is your broker) are both trying to gouge to the max anyway rather than doing the trade at the market prevailing when your order was submitted.

At IB, I generally have to wait a few seconds to a minute or two to get a bond fill. But I've never had to wait longer. (This doesn't mean that games don't get played by the underlying desk, which I'll explain in postscript). At E*Trade, even if the bonds are listed as "Firm: Immediately Executable", I generally have to wait longer than that. At BrownCo, orders were submitted by phone, so executions were generally immediate: I got a fill while I was still on the phone. At Harris, executions varied as far as how long they took, but they were generally acceptably quick.

The fact that Vanguard (or whoever it was) adjusted the price when you complained means they knew they were screwing you around. They had the bonds in inventory but were expecting the market to move higher and wanted to gouge you the price. You complained, so they offered you the bonds at the price prevailing at time you submitted your order. They didn't do you a favor. They did themselves a favor by forestalling a possible SEC complaint.


PS IB doesn't hold bond inventory. They attempt to execute on inventory offered out by bond desks, of which there are a hundred or so nationally. Lots of times, the underlying desk won't release the bonds, so IB can't execute. And lots of times the following game gets played. IB requires bond orders to be written as limit orders for their own and for their customers’ protection. The policy is well-meant, but awkward, inconvenient, and sometimes counterproductive. (IB is a stock/futures/option firm, not a bond firm, and nobody does a better job of cheap, fast executions.) Bonds are an after-thought, and some of the trading policies for bonds were borrowed from the models that work successfully for stocks/futures. E.g., in the pre-market and post-market, only limit orders can be written. Market orders are rejected, because IB wants to protect itself and its customers. A lot of savvy traders complain, saying they know what they are doing and are willing to accept the consequences. But IB is run by some tough-minded people who care about both IB and about customers, and the policies they make are easy to understand and to defend.

OK. The game I see being played by the underlying desk is this: IB is quoting the inside market on an issue: the national best offer and size, the national best ask and size, and the last trade and size.

An aside: Yes, I know there are no national clearing places (aka, exchanges) for bonds the way there are for stocks. But there is a functionally-equivalent, electronic quoting system. To their credit, Fidelity quotes the NASD prices. E*Trade and most other brokers ---e.g. Scottrade-- quote a markup of those prices.

If I attempt to execute through IB, IB sends my order to the underlying desk. But because it is a limit order (even if the price specified is the offer and therefore should be immediately executable), the desk can reject it, which they often do, not explicitly, but by not enabling IB to execute. So my order sits there on IB’s market line. Meanwhile, the underlying desk raises the offering price, which IB now quotes. So, obviously, my order isn’t going to be executed, because I’m now bidding less than the offer. So I’ll cancel. Shortly thereafter, the underlying desk will drop their offer back to the original price. If I wait around and track prices, I’ll see the price continue to vary throughout the day. Sometimes I’ve gone back and gotten the bonds cheaper than my original offer. But at the time I submitted my first offer, the underlying desk (once they had an offer for me) was looking for an even better price.

I don’t blame IB one bit. They are doing the best they can with a fragmented, institutionally-dominated market, trying to provide their customers with cheap, fast executions. I don’t blame the underlying desks. They know how the bond market works. They know that small, retail bond buyers will roll over rather than fight back. So there is no incentive for them to change their business models. The group of people I do blame is bond customers. Unless and until they get themselves organized and fight back, nothing is going to change. Fighting back can take either of two forms: the regulatory route or the transfer accounts route. I have more faith in the latter. That’s just me, but that’s why I attempt to execute through IB whenever I can. To the extent that they flourish is the extent to which E*Trade and their ilk lose market share and have to reconsider their business model. There is no reason why bond investors can’t force fees down the same way that stock investors have forced fees down. We bond investors don’t do the share volume the stock guys do, but we might do enough dollar volume to be a presence worth catering to. But we have to present a united front instead of being so dividable and conquerable, as we presently are.

More than once I’ve thought about becoming a market marker in bonds, just I could meet what I perceive to be the needs of small investors. It wouldn’t be impossible to do. The technology and capital requirements aren’t huge, but the personal commitment would be. And I have to ask myself if that’s what I really want to do. I don’t need the money to be gained. Nor would the service, for the most part, be appreciated. And the last thing I want to do would be to help the rich get richer. A pox on them. But my heart does go out to the little guy who had the discipline to create savings that she or he is now trying to turn into investments as a way of moving purchasing power forward in time. The vultures and parasites that are Wall Street prey on the little guys (who, admittedly, are often their own worst enemies). A decent bond shop would be a help to them. IB isn’t even close to what that small investor needs, but they are far better than their competitors, and so I support them.

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