A major financial information firm held an event recently to tout a new and improved municipal bond product that blends trade data with information and quotes from traders, underwriters and other bond professionals. In other words, the product blends a collection of trade data with human input. This important balance is the key ingredient in creating a more accurate value. The municipal bond industry has been following the rest of Wall Street down the path to a cold world of statistics driven by algorithms and various formulas to try to perfect an imperfect product. More than any other product, municipals rely on the “human element.” To safely navigate the perils of the municipal market one must rely on not only on the maps provided by the complex sorting and collection of data but also the experience and knowledge of the people who know how to interpret them. The goal of many seems to be to force the round edges of municipal bonds into the square hole of stocks or United States securities.
One has to look no further than our national pastime, baseball, to see how statistics are being employed to help managers understand hitting and pitching trends so they can make more educated decisions. However, occasionally the statistics are followed blindly as was the case in last year’s World Series. Los Angeles Dodger Manager Dave Roberts took his starter out of a game that he was pitching well, simply because the statistics warned against him continuing the game after just four innings. In the past, managers like Billy Martin and Casey Stengel would use their gut instincts” and vast experience to make informed decisions, without a book of raw data to direct them. Back on Wall Street, the gradual elimination of specialists on the stock exchange floor, who operated much the same way as the old baseball managers, eliminated the human element and instinctual decisions based on non-quantifiable experience. Progress in compiling and sorting data is a good thing. It allows us to recognize patterns and help predict future outcomes.
However, we should always leave room for the human element; things that cannot be documented and behavior that cannot be formulized.
Municipal bonds have always lagged behind the rest of Wall Street in terms of modernization, possibly because of the product being so complicated but more likely because municipals were not the main profit centers for most firms. One of the earliest applications of computers in municipals was in underwriting in the late 1960’s and early 1970’s. The area in municipals that was able to integrate computers the most seamlessly was the new issue or primary market. Computers were huge, full of pulsating, steamy wiring that required them to be stored in temperature-controlled room much like a wine cellar.
Municipal bond underwriting meetings were a group effort of firms of all sizes with different amounts of risk. After coming up with a scale acceptable to the members and determining the coupons, the manager would calculate a bid for the issue. This is where the room-size computer came in as the manager would leave the room much like Oz going behind the curtain. As the members, at that time mostly white males dressed in dark suits and white shirts, waited for the final pricing with images of blinking lights and puffs of smoke in their heads, the clock for the bid time kept ticking. The human element was an essential component of the bid. Syndicate members discussed buy side’s interest, trends in structure, ratings, couponing and levels. Market information was not dissected by the computer. The computer was there to calculate the math behind the bid quickly and correctly. Computers were a tool used by players in the marketplace as a vehicle to a destination, not the destination itself.
JFK said in his Inaugural Address, “those who foolishly sought power by riding the back of the tiger ended up inside.” Computers are the present and the future but if we forget to add imagination and reason to the use of computers we will become too predictable and rigid. Raw data must always be balanced and molded by human experience. Not everything in life can be measured and predictable, especially a product that, according to the MSRB, has a market size of $3.9 trillion, averages almost $11 billion in trades daily, has 1 million CUSIP’s, and spans more than 50,000 issuers with various ratings, purposes, use of proceeds, coupons and call structures and does not trade on an exchange. Computers must remain a tool to be respected and used in a manner that truly reflects this unique market place and the nuances created by the human element.
