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?