Wall Street is reeling from the sharp decline in bond prices that followed the Federal Reserve Board's new tight monetary policy announced on Oct. 6.
Banks, brokers and dealers have lost untold millions -- probably hundreds of millions -- of dollars in the last four weeks. Chemical Bank alone lost $6 million in its bond trading accounts since Oct. 6.At least four small dealers in municipal bonds have gone out of business in recent days, and more may do so in the future.
Big brokerage houses have been hurt, too. But the large securities firms have other sources of income to offset losses in the bond department, noted Robert Linton, chairman of Drexel Burnham Lambert Inc.
Even so, many major securities firms may have taken big enough losses in their bond accounts to wipe out fourth-quarter profits, according to one Wall Street expert.
In all, the value of outstanding corporate, municipal and government debt securities has declined by $100 billion since Oct. 6.
Not all -- not even most -- of that $100 billion loss will be realized, however. Many investors in bonds -- such as insurance companies, pension funds and banks that hold the securities for investment purposes rather than trading purposes -- do not have to recognize the decline in the value of their holdings unless they sell the bonds.
The New York Stock Exchange reportedly is reviewing the adequacy of capital at many of its member firms in the wake of the decline in bond prices. Bonds are a big part of the capitol base of many large brokerage houses.
"We talk about B.V. and A.V., before Volcker and after Volcker," said Donald Regan, chairman of Merrill Lynch & Co., the nation's largest securities firm. Paul A. Volcker is chairman of the Federal Reserve.
Regan said that Merrill Lynch lost a lot of money in its bond trading department, but much less than the $6 million Chemical Bank lost. The vice president in charge of bonds at Chemical Bank was fired, although the bank said the firing was not related to the recent losses.
Bonds are debt securities issued by governments and corporations that carry a guaranteed interest rate on the face amount of the security. So, for example, a $1,000 bond which carries an interest coupon of 6 percent will return $60 a year to an investor.
At some point -- 15, 20 or 25 years after issuance, say -- the issuing company or government pays back to the investor the face value of the bond.
Like common stocks, bonds can be bought and sold. Because the interest rate is fixed, if the going rate of interest is higher than the rate the bond pays, investors pay less than the face amount of the bond. For example, if going rates are 7.5 percent, then a $1,000 bond with a 6 percent interest rate would sell for $800.
When the Federal Reserve announced its tight-money policy on Oct. 6, interest rates soared.As a result, bond prices plummeted as much as $100 a bond in many cases.
When dealers sold their bonds -- out of panic, to cut losses or to fulfill previous committments -- they lost money on each bond sold.
"It was a mess," said Herbert Allen Jr., president of Allen & Co., a big Wall Street investment house.
Many brokers, dealers and banks claim not to have lost any money -- or even to have made money -- during recent weeks. And for some that is true.
A dealer who made a commitment on Oct. 5 to sell a bond he did not yet own (selling "short," as brokers put it), made money -- at least on that transaction. If the broker made a commitment to sell the bond for $900, say, and the price fell to $850, he could buy the bond for $850 and sell it to a purchaser at $900.
"Sure, there were some who made money being short," said one knowledgeable source. "But don't you ever believe that the whole Street was short."
Frederick Gorsetman, who set up his own municipal bond trading firm in August 1978, threw in the towel just after the Volcker announcement.
"The markets became so volatile that nobody was properly compensating you for the kind of risk you had to take," Gorsetman said.
"We sustained quite a lot of loss, and I had to decide whether to put up more chips or get out," he said."I decided to get out."
"There are a lot of other people hurting, too," Gorsetman said.
At least three other municipal bond dealers have decided to go out of business, according to the Public Securities Association, including Valeriano, O'Brien; Park, Ryan Inc.; and Wilson White, Belf, Lake and Rochland.
"I don't think we got beat any worse than anybody else," said one small bond dealer who is trying to stay in business. "But we've got nothing else to balance against our losses. Chemical Bank is not going to close because of its bond department."
Bond dealers are angry at the Federal Reserve, not only for unleashing the new tight-money policy on Oct. 6, but for printing a mistaken money growth number on Oct. 18 that showed the money supply had increased sharply despite its tightening efforts. On Oct. 25, the Fed said the money supply had not grown by $2.8 billion but actually had declined markedly. It said the report was wrong because Manufacturers Hanover Trust had made a $4 billion error in reporting its deposits to the Fed.
"When we saw that number on Oct. 18, we were scared," said another bond dealer. "We thought the Fed's going to have to stick it to us again."
Market analysts say that dealers panicked again on Oct. 19, selling off bonds and depressing bond prices further.
Brokerage houses and dealers have to revalue their bonds to reflect market prices. Regan said that Merrill Lynch "marks to market" every week. But pension funds and insurance companies, for example, do not. Because these institutions -- which hold most of the corporate bonds -- can hold the securities to maturity and collect face value, they do not have to worry about the daily value of their portfolio.
As a result, while the total value of bonds, notes and bills (which are short-term debt securities) declined $100 billion in the three weeks following the Fed's new policy, nothing approaching that figure will be shown as a loss in the business community.
In the last few days, bond prices have recovered somewhat, although they are still far below what they were in early October.
But that is small consolation for Frederick Gorsetman.
"I'm keeping my broker-dealer license, and I guess I'll try to find another job in the securities industry. But don't ask me why," he said.