New Study Shows Post-Crisis Regulations Hurt Bond Liquidity

In an article posted on the Liberty Street Economics blog of the Federal Reserve Bank of New York, authors Tobias Adrian, Nina Boyarchenko and Or Shachar (collectively, the “authors”) explained the results of a recent study, which indicated that corporate bond liquidity has been adversely affected by post-crisis regulation.

The authors analyzed FINRA Trade Reporting and Compliance (“TRACE”) data in order to evaluate trade activity and measure corporate bond market liquidity. By utilizing the information provided by TRACE reports, the authors were able to determine which parent bank holding company (“BHC”) corresponded to a dealer in a particular trade. The authors then calculated bond liquidity by using common corporate bond liquidity metrics and incorporating constraints based on the balance sheet of the relevant BHC.

The economists stated that the results demonstrate the negative impact on bond liquidity of post-crisis regulation. Further, the authors argue that actual trading behavior data supports this conclusion.

Lofchie Comment: The results of this study are welcome and expected. For quite some time, the regulators seemed to deny there was any proof that the Dodd-Frank regulations damaged liquidity, notwithstanding both evidence to the contrary and common sense (how could regulations that heavily burden trading not impact liquidity?). That said, the fact that the regulations impair liquidity does not mean that the regulations are bad. All it means is that the regulations create trade-offs; one can reasonably argue that the diminished liquidity is worthwhile. It is important, however, that the regulators admit that the trade-offs exist (“it’s all good” is not the way the world works: regulations have both costs and benefits).

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