The Vanished Market-Making Balance Sheet

The claim

"Part of the regulatory reform [after 2008] was to penalize those who made markets and held market making capital within the banking system, particularly for fixed income. There is roughly 10 percent of the amount of capital for fixed income market making today as there was in 2008, and the market is three times its size." Marc Rowan, answering a question from Nicolai Tangen about what happens to liquidity.¹

The arithmetic

If the figures hold, the capital available to intermediate a given dollar of fixed income has fallen by roughly 97 percent: one tenth the balance sheet set against three times the outstanding market. Rowan states two consequences that follow. In normal conditions: "Today, in the best of times, in the most liquid market, it takes 5 days to sell an investment grade corporate bond." In stressed conditions: "The next time we get a significant risk-off event, my own view is we should expect little to no liquidity in publicly traded fixed income."¹

Why this is an unusually useful claim

Most of what Rowan argues elsewhere is a matter of framing, which is hard to independently check. This is not. Dealer inventory levels, primary dealer positions, and corporate bond turnover are all measured, public series, which makes the claim specific, dated, directional, and falsifiable in a way most of his other claims are not. It is also the claim that cuts most directly against his own industry's usual pitch, which is a reason to take it seriously rather than dismiss it: the standard private-markets argument is accept illiquidity, get paid for it, while this claim says the liquidity premium on the public side is being paid for a feature that has quietly stopped existing. Rowan states the point bluntly in the same conversation: "oh and by the way, there is no liquidity in public fixed income markets."¹

The regulatory irony

Post-crisis rules made it expensive for banks to warehouse bond inventory, on the reasonable theory that warehoused inventory is exactly what helped cause the 2008 crisis. The intended effect was less risk sitting inside banks. The unintended effect was that the function the inventory performed, continuous two-sided markets, left with it. The same reform that pushed credit risk out of the banking system also pushed out the shock absorber that made public trading liquid, and Rowan never explicitly connects the two halves of that trade: the system became less levered and less liquid at the same time, and the second is the price of the first.¹

Already stress tested twice

Asked whether the change has really been stress tested, Rowan disagrees immediately: "Oh, we have. We've seen it twice. We saw it in COVID, where ETFs in fixed income almost broke. And we saw it in the UK and LDI," a reference to Britain's liability-driven investment pension crisis.¹ Both cases involved a security everyone believed was reliably sellable turning out to be sellable only in small size, and only before everyone else tried to sell at once, meaning the liquidity was real for any single participant and illusory in aggregate.

Where he takes it

The conclusion is a forecast about private markets rather than public ones: "Private markets today in investment grade don't trade. Okay, you're going to see liquidity come into private markets. That will mean for private markets everyday liquidity, everyday pricing, everyday price discovery. If you think about investment grade at least, you will have the same issuers, the same ratings, the same size, and you will have similar liquidity over time." The claim is convergence from both directions at once: public investment grade is less liquid than advertised, private investment grade is becoming more liquid than it was, and the two are meeting in the middle.¹

Tensions

The core figures are unsourced: roughly 10 percent and three times its size are both stated from memory in conversation by an interested party, and while the direction is widely accepted, the exact magnitude is not established here. "Five days to sell an investment grade corporate bond" is also imprecise about size, since a small retail lot trades instantly while a large institutional block is a different question entirely, and the claim almost certainly means the latter without saying so. Electronic and all-to-all trading go unmentioned throughout: dealer balance sheets shrank, but part of the intermediation function migrated to portfolio trading, exchange-traded fund creation and redemption, and non-bank liquidity providers, so treating the missing capital as simply removed rather than partly relocated overstates the case somewhat. And the claim plainly suits the interests of the person making it, since public fixed income being less liquid than advertised is the precondition for selling private fixed income to allocators who believed they were buying liquidity, which is exactly why the claim deserves checking rather than simple acceptance.¹