Tuesday, June 11, 2013

An Example of an Excessive Muni Markup

By Tim Dulaney, PhD and Tim Husson, PhD

This week we've been discussing excessive markups in the municipal bond market.  Now that we've outlined what excessive markups are, you might be wondering what such markups actually look like in the EMMA data.

The following figure shows the October 6, 2009 EMMA trading activity in a $6.54 million State of California municipal bond issued in 2009.  A customer purchased $1,000,000 of the issue at $113.80, paying $3.507 more than the average inter-dealer price for trades of similar size that day.1



The markup charged to this customer was more than 20 times the median markup for trades of similar size ($0.15) and was clearly excessive.  This markup amounted to a $35,072 transfer of wealth directly from the investor to the brokerage industry.

On January 11, 2011, the customer who made the purchase above sold the bonds at $99.117. The following figure shows the EMMA trading activity in the same bond.   The average inter-dealer price for this bond was $100.158 and so the customer was charged a markdown of $1.04 per $100 face-value bond.



This markdown, approximately 7 times the median markdown, represented another $10,408 transfer of wealth from the customer to the brokerage industry and was also excessive.

The customer purchased the bonds at $113.80 and sold them for $99.117, a loss of about $14.683.  Judging by the average inter-dealer trades approximately 31% of this loss was due to the excessive commissions charged on the purchase and sale of the bonds.  Had the investor known that the roundtrip cost of this 15 month trade would amount to $45,480, the trade would likely have never taken place.

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1 The average means the volume-weighted average of inter-dealer prices that traded on the same calendar date.

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