August 29, 2013

6 Key Concerns With the Fed’s Take on ETFs

There are many holes in, and questions about, Bernanke's argument that leveraged and inverse ETFs are hurting the markets

Fed Chairman Ben Bernanke. (Photo: AP) Fed Chairman Ben Bernanke. (Photo: AP)

So, the Federal Reserve says that leveraged and inverse ETFs could destabilize financial markets during periods of high volatility? Really?

Let’s take a hard look at the argument.

1. Defining Destabilization 

Are we talking about the same type of market destabilization experienced by the U.S. banking system that the Fed was allegedly supervising during the 2008-'09 meltdown? Or is the Fed referring to the sort of petty destabilization that the U.S. Treasury market (TLT) is currently undergoing because of Bernanke & Co.’s various monetary experiments?  

2. Leverage Issues

Speaking of leverage, why is the central bank’s debt-to-equity ratio higher today than Lehman Brothers right before it went bust? And why do the largest U.S. banks (XLF) still have higher leverage ratios compared to their European counterparts? Isn’t this fact a potentially more deadly threat to market stability than leveraged and short ETFs?

What is the Federal Reserve’s definition of “market stability,” anyway? Is it the $200 billion in mark-to-market year-to-date losses suffered by the Fed’s Treasury bond portfolio due to the latest episode of rising interest rates?

3. Losses & Solvency

And if rates keep rising, could losses in Federal Reserve Bank’s fixed-income portfolio eventually top $1 trillion? What kind of meltdown would that be?

And could it lead to a central bank solvency crisis? Tell us, who at that point would be on the hook for bailing out the Fed and its highly esteemed members?

4. Inverse/Leveraged ETFs

What sort of market destabilization track record do inverse and leveraged ETFs have? For example, did they instigate market disorder during the 2008-'09 financial crisis?

What about the Flash Crash of 2010? Who were the real culprits behind these financial shocks?

When, besides never, have inverse and leveraged ETFs ever played a leading role in disrupting financial markets? Shouldn’t the Fed’s report have begun and ended with “Trainor (2010) cannot find evidence that suggests leveraged ETFs increase volatility?”

5. Stability Defined

Could it be the Fed’s definition of “market stability” is the reflation of equity and home prices? Is that it? Or is it Fed’s steroid-laced balance sheet that has swelled from $908 billion at the beginning of 2008 to $3.59 trillion in 2013?

Furthermore, what is the Fed’s main point in this hate-filled report about leveraged and inverse ETFs, anyway? Is it remotely possible the Fed’s real purpose is to distract the public’s attention from its own shortcomings?

6. Feds, Naps

Finally, if the Federal Reserve is such a trustworthy institution as it would like the public to believe, how come the current version is its fourth banking iteration?

P.S. If you dare read the Federal Reserve Board’s report titled Are Leveraged and Inverse ETFs the New Portfolio Insurers? try not to fall asleep.

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The ETF Advisor Pro Newsletter helps financial advisors to help their clients to be on the right side of the market. It identifies major market trends along with actionable ETF strategies.

 

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