On today’s show we’re talking about whether markets really need a market maker. But first we need to define what a market maker is. The role of the market maker is to introduce liquidity into the market. The problem in many markets is that too much time passes between the buyer and the seller getting together. This passage of time means that the market price can fluctuate up and down depending on the number of buyers and sellers and the spread between the bid and the ask.
Exactly what does the market maker do? They step in when there is no buyer and they buy, and they step in and sell first when there is no seller. The role of the market maker is to ensure that any time there is a sale, there is someone waiting to buy. Whenever there is a buyer, they step in and sell. In exchange for providing this service, the market maker makes a small profit margin. The market maker is not exposing themselves to undue risk because there is an expectation that the market will continue to operate in an orderly fashion.
The major stock exchanges around the world work on this premise. When someone buys shares of Tesla on the NASDAQ at the market price, they are buying the shares from the market maker, not the seller of shares. The market maker ensures that when someone put shares for sale maybe two minutes ago, there would be someone available to make the trade without having to wait for the trade to be fulfilled when a buyer materializes.
Markets of all types exist throughout the world without the role of a market maker. The real estate market in my local community has no market maker. When you bargain for a bushel of tomatoes at the farmers market, there is no market maker.
The Federal Reserve said on June 15 that it will begin buying individual corporate bonds under its Secondary Market Corporate Credit Facility. Let me get this straight, I could be a captain of US industry with the need for additional debt. The banks won’t lend it because there isn’t sufficient collateral. The income isn’t consistent enough to sell the bonds because we have a global pandemic on our hands. So the Fed will step in and buy that debt that is too toxic for real investors to touch. All of this is being justified as providing market liquidity.
The central bank also spelled out for the first time how it plans to implement its buying strategy, saying it would follow a diversified market index of U.S. corporate bonds created expressly for the facility. The Fed built the index internally, and a spokesman couldn’t immediately say whether its details would be made public.
So here’s the rule that needs to be followed. It’s listed under section 13.3 of the Federal Reserve Act. An index assures the Fed complies with the spirit of the law under Section 13.3 of the Federal Reserve Act which says emergency lending facilities must be broad based, and provides a mechanism for the central bank to avoid industry concentration.
A program or facility that is structured to remove assets from the balance sheet of a single and specific company, or that is established for the purpose of assisting a single and specific company avoid bankruptcy, resolution under title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act, or any other Federal or State insolvency proceeding, shall not be considered a program or facility with broad-based eligibility.
So here’s the deal. The Fed is going to make up an index that has a few companies in the index, or who knows, maybe even one company so they can stay in compliance with the letter of the rule in section 13.3 of the act.
That explains why the stock market indices are at such crazy levels, despite the economic downturn. The Fed is going to buy corporate America’s bad debt, and they’re going to do it with printed money.
That folks looks like a bailout, and definitely not like market maker activity.