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Markets and Liquidity, Part 1 of Many

I’ve been working on White Paper on Liquidity and the idea of a “market,” and plan to post some pieces of it here over the next week or so.

But this is too good to pass up, and I’m late to the game as is.

On 15 September, the CFTC and the SEC held a joint “public roundtable discussion” on Swap Execution Facilities (SEFs). Part 1 is here, Part 2 here.

What is most amazing, if you didn’t pay attention to the markets, is how few actual transactions occur in the “derivatives market”—at least according to people who work in the Industry and are discussants.

Take, for example, the Credit Swaps Market. According to ISDA, the Credit Default Swaps Market in 2009 declined to $38.6 trillion; that’s $38,600,000,000,000, give or take forty or fifty billion.

Sounds like a lot, no? Strangely, there’s virtually no liquidity associated with that $38.6T. According to the testimony in Part 1, the most frequently traded CDS—GE, presumably because they bring good things to life (or at least have DoD contracts)—trades around 15 times a day. That might be impressive for a penny stock, but it’s not exactly the type of thing that makes you think “Wow, that’s a market!”

The implications are clear: the bid-offer will be wide (think FX rates from your local bank, or gold prices from Goldline), the loss when one tries to get out of the trade makes “driving a new car off the lot” look like a blip, and any dispute will be resolved against your favor.

In short, there is—and should be—very little retail demand for these products, for very good reason. Paul Volcker’s description of the ATM as the only financial innovation in the past 25 years that helped people has never seemed so true.

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