Let’s reflect for 11 minutes on specific market, rather than on “free markets” in the abstract, for a real-world perspective on economic theory.

Simple fact that’s apparently obvious to everyone who trades muni bonds but not to me: 1 December is a common payout date, meaning that January & February usually have lower yields as there’s more money (tagged “for investing in bonds”) looking for its next home. So much for optimal selection of the best securities throughout all time or statistical arbitrage of the rates.

Not that there’s not an efficient-markets explanation for this or that Marshallian S&D is irrelevant. But there are some obvious kinks to it, right? You might thumbnail this as “institutions” if you have an economic-theory label gun in your holster.

  • Besides the regular cyclic dependence (I can easily imagine some theorist who doesn’t participate in the market assuming it must “obviously” be arbed away. Some papers on asset switching come to mind),
  • in this market we talk about fixed supply coming onto the market at a given time window, very different than a posted-offer (retail) or 
  • so your econ 101 S&D picture wouldn’t quite capture let’s say $AMZN’s decision of how to list its bonds. There’s some invisible demand curve
    (I drew this for an older post, not gonna re-draw an S&D curve.) that $AMZN is going to try to guess at (and they might hire some “banksters” to help them). Then they can delay or move forward that fixed vertical supply curve (they probably have pre decided how much they want to borrow based on their internal models and decision processes). So there’s a time element (try to list in Jan/Feb, if you “can” wait! Do or don’t list along with this other major issuance. Competing for the analysts’ attention. Etc.) and much less of a price element, since that’s pre-decided before listing.

    Sure, maybe there’ll be an OTC secondary market that changes the price afterwards. But now already we’ve split an adze through the “perfect efficiency” idea, simply by questioning whether it’s the primary auction or secondary trading we’re calling efficient. Now it sounds much more plausible that markets with more volume and smarter participants are going to price more “accurately” (which we haven’t defined and couldn’t, since defaults are one-off probabilities) and simply by questioning the axiom we’ve undermined the theorists’ go-to assumptions. If you wanted to model this market, you might start with something quite different to “Assume fully informed traders and no arbitrage condition”. You might start with, like, actual facts or data on trade records, look at legal documents, record phone calls, ….

  • And what about the ubiquitous government-versus-markets dichotomy? Oh, snap! This is private investors lending small (not federal) governments money to build highways. Hmm, I guess that “four legs good, two legs baaaaad” dichotomy is incoherent.
  • As far as politics goes, GARVEE’s must be a really important political issue (how to arrange for surface transport across the United States), but as it’s not a sex scandal or on either American party’s agenda to trash the other, I guess it’s unfit for discussion in the news.

Any market I look a little closer at, if you squint you can see the EMH in the outlines. But the details are more complicated and much more like a transaction you can imagine real people (who can afford lawyers) engaging in. Very head-to-head, can-we-make-a-deal, size-matters, quantity-over-price, get-it-done-rather-than-optimise-the-exact-details, ….

Equally as much as I might want to show this to overzealous, oversimple free-marketeers, I’d show it to the anti-capitalist zealots too. Does this sound like a monopoly of power by either large corporations or plutocrats? There’s a competitive playing field gunning for however much money is out there, you have to argue your case (marketing) for why the people with investors’ money (let’s say a pension fund) should trust you’ll pay them back, in general a lot of “power” floating around but sounds like they keep each other in check. It’s not like $AMZN can force people to subscribe to its bond issuance. And I can even imagine a legitimate, contributive role for high-powered lawyers and investment “banksters”. Do the computer programmers at $AMZN know how to market and list securities, track down and convince the people safeguarding the big sacks of money to lend it to them? Other than a prejudice toward large size, Doesn’t sound very plutocratic to me.

Anyway. I listened to this and got the feeling I have many times on learning just some basic obvious stuff about real markets. Like wow, grand economic theory is missing details that are obvious to actual market participants, mired in overgeneralisations and simplifications, and the theorist who gets all tooth-and-claw about their holy assumptions needs to get more exposure to the real world.

Just from the merest actual facts about this market regime I’m already thrust into a “middle ground” where, sure, the price system, self-interest, and competition seem like they’re going to be pretty good and robust-over-time and so on. But certainly not “optimal”! And certainly not full Intrade-worshipper style, where price corresponds to exact probabilities and markets are a crystal ball | prediction engine. So the extremists on both ends lose, on this story.

Amazing what you can learn about the world when you actually observe it before writing the theory.

“To generalize is to be an idiot. To particularize alone is a distinction of merit.” —William Blake

Hat tip @munilass.

PS Obviously I don’t know anything about munis or corporate bonds. All of my “you“‘s and “I“‘s above can be interpreted in a strict sense as “Now that I’ve learned the very first thing about this real market, how does plausible do various abstract economic-theory ideas sound afterwards?” If you work in these markets and I said something wrong, please correct me.


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