Photo Credit: Mike Beauregard || Frozen solid, right?

The talk regarding an illiquid public corporate bond market goes on, and if you’ve read me over the past year on this topic, you know that I don’t think it is a serious issue. One of the reasons why it is not a big issue is that the public bond market is designed to be low liquidity.

It starts with how bonds are originally issued. New bonds and new stocks are issued in similar ways, but with a few differences:

IPOs on Wall Street get allocated if they are oversubscribed. When they are oversubscribed, the deal is typically good, and everyone wants more, so they put in huge orders. The dealer desks on Wall Street solves this problem by allocating proportionate to the size that they have come to understand the managers in question typically buy and sell at, with some adjustment for account profitability.

Those that flip cheap bonds for a quick profit typically get penalized, and their allocations get reduced. Those that buy bonds in the open market when the deal breaks and becomes “free to trade” can become eligible for larger allocations. The dealer desks work in this way because they want the buyers to be long-term holders, and not seekers of easy profits from flipping. That doesn’t mean you can never trade a bond you have bought — just not in the first month, subject to a few exceptions like a small allocation, your credit analyst rejected it, etc. (Oh, and if one of those exceptions exists, the primary dealers want to do the secondary trade. If the exceptions don’t exist, they don’t want to know about it.)