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ETFs – The Next Accident Waiting to Happen?

Where will the next point of instability be? Not what will trigger the next liquidity and credit crunch and cause the next landslide of panic selling and losses. We can already see many candidates for the trigger. But what will be the mechanism by which it is amplified and spread?

I think that in a couple of years, unless something alters the current trends in money flows, we will come to know ETFs the way we already know the securitization and packaging of  sub-prime mortgages into CDOs. I think the signs are already there to suggest ETFs are where the instability and risk is accumulating. If I am in any way correct then ETFs will be to the next stage in our on-going state of siege-mentality crisis what CDOs were to the last.

To substantiate this claim I have to tell you in simplified terms what an ETF is. And then explain how, despite all the differences between mortgage backed CDOs and ETFs, the latter generally being based on stocks, bonds and commodities rather than mortgages, they are undergoing the same evolution from simple to opaque, stable to unstable, are being seen as the provider of liquidity and risk-controlled ‘exposure to risk’, just as CDOs were, when in fact they are concentrating risk and will, in a moment of panic, cause liquidity and lending to collapse.

In any ecosystem there are certain niches: large carnivore, carrion eater, arboreal fruit eater etc. These niches can persist even as the particular species that fill them go extinct. What you find is that another species, from a different family, will evolve into the niche because it is ’empty’ and therefore there is ‘a job’ going free. So it is in the present ecosystem of global finance. In many ways the ETF is evolving, or being bred, to fill the same niche that Securitized debts (CDOs) filled only a few years ago.

Here is how a paper for the Bank for International Settlements (BIS) describes the rise of the ETF.

…in the low global interest rate environment in 2002–03, structured credit products [CDOs] were marketed to gear up investment returns for institutional investors …as they offered higher returns to comparably rated plain vanilla assets.

The financial crisis experience, however, dampened investors’ appetite for structured credit products. Yet the low global interest rates that supported growth in structured credit products have returned, with institutional investors facing similar problems to those back in 2002–03. This time, financial intermediaries have responded by adding some innovative features to existing plain vanilla investment funds.   (P.1)

The ‘same problems’ the BIS mentions are that when interest rates are low banks can’t make much return by simply lending out money. So the desire for a higher return spurs the invention of financial products that promise that special combination of a higher return but without the higher risk that should come with it.  Securitization and CDOs promised it. ETFs promise it.

So what is a basic ETF?

An ETF (Exchange Traded Funds) is an investment fund which holds a mix of stocks, bonds or commodities such that it emulates and thus tracks the over all value and performance of the particular exchange it is based on, such as the Dow or the NASDAQ. So when you buy a share in an ETF you are buying, as it were, a tiny, representative slice of all the stocks and shares, bonds or commodities which characterize the whole market.  Just as a mortgage security and CDO was a way of buying a little slice of a pool of mortgages, so an ETF is made of ‘slices’ of a basket of shares, bonds or commodities depending on the kind of ETF. In both cases the ‘product’ is marketed as a way of investing in a basket of stuff so as to spread the risk that comes with buying all of one thing. Of course as soon as something is understood as a way of  spreading or lessening the risk it is immediately seen as a way of ‘getting exposure’ to more risky things  – in a less risky way of course. A less risky way of taking risks – the claim of modern financial innovation boiled down to its essence.  So ETFs are marketed as a way of investing in less accessible and more ‘risky’ markets via a product that ‘smooths out’ the risks for you.  To me these are the obvious parallels between securities/CDOs and ETFs, on the ‘risk’ side.

There are also parallels on the ‘liquidity’ side. As a recent paper by the Financial Stability Board (FSB) on ETFs says,

… their main advantage is to combine the low-cost diversification benefits of index-linked and basket products with the high liquidity and tradability of individual stocks.

What makes ETFs different from other kinds of investment funds, like Money Market Funds, is that shares in the ETF can be bought and sold like any other stock or share, on a second by second basis. Whereas Money Market Funds are redeemable and valued only once a day. Money Market funds are sometimes characterized, especially by those offering ETFs, as large, conservative and slow creatures. The herbivores of the financial world. Whereas ETFs are seen as faster and more responsive, combining the basket nature of a fund but with the instant tradability of stocks.

ETFs are also seen as increasing and therefore providing liquidity not only to the buyers in a market but to the sellers as well. Some of the biggest ETFs are based, in part at least, on shares from emerging markets which many investors would not know much about or dare to purchase. As the BIS paper says,

Investors’ desire to seek higher returns by taking exposure to less liquid emerging market equities and other assets through ETFs that guarantee market liquidity…. (P.1)

Thus an ETF listed and trading in NY may contain shares in Korean companies. Suddenly those more obscure Korean stocks are moving in NY.  So ETFs claim to provide liquidity for buyers and sellers – the whole market. Good for you, good for me – good for everyone.

So that is a very simple sketch of ETFs and some of the claims made for them. The important point for me is how ETFs are in many ways slipping in to the niche left vacant by Securitized products like CDOs. Same sorts of claims about safety versus risk, and about providing liquidity. ETFs and those who run them are, it seems to me, positioning themselves as not only good and safe, but by being liquidity providers being also systemically important for the health of the broader market. Sound familiar at all?

Their growth.

ETFs were  invented back in the 90’s. The first ETF was on the Toronto exchange in 1989. It was 1993 when the first ETF appeared in America. By 2002 there were 246 around the globe. They continued to grow but  so long as the securitized, mortgage backed CDOs reigned supreme the ETF was its poor relation. With the collapse in demand for securitized, mortgage-backed products, the ETF, I think, is poised to emerge as the successor.  In 2005 ETFs held a mere $410 billion in Assets Under Management (AUM). Enter the crash and the heart-attack contraction in Securitization, and by 2010 ETFs had tripled to $1.3 Trillion Assets Under Management and are growing.

Large as this sounds it is worth keeping in mind that the ETF market is actually still small, just 5% compared to the much more established Mutual Fund market. But we are still in the early days of the rise of the ETF. The equivalent, I would guess, of where Mortgage backed securities and CDOs were in 2002 or earlier. It is the rate of growth, not its size which seems to me to tell the story. The ETF industry has grown at 40% a year over the past 10 years! The broader market has achieved 5%.

ETFs are big, getting bigger and are everywhere in every market tracking every sort of asset from simple stocks, to corporate and sovereign debt and commodities from gold and oil to wheat and soya. According to the FSB paper from which I’ve already quoted (P.2) at the end of  2010 there were 2500 ETFs offered by 130 companies, traded on over 40 exchanges.

Now before I start on what I consider to be the dangers I want to make it clear that I don’t think ETFs are necessarily a bad thing. But just as with Securitization they can become a very bad thing. I also don’t think disaster is upon us with ETFs. But I do think they we can see signs that they are a possible, even likely venue for the same unwise, unsafe, unstable accumulation of ignored risk and systemic instability.

Reasons not to be cheerful.

So here is a brief and necessarily incomplete look at some of the reasons I think ETFs are becoming dangerous.  Disclaimer – I am not an expert in ETFs. As with everything I write it as an educated person who has read what he can find and has tried to think clearly about what he has read. Nothing more.

When ETFs began they were what is now referred to as plain vanilla or physical ETFs. Such ETFs replicate the broader market by simply buying a representative basket of the shares which make up the market . The ETF’s creator/Sponsor gives this basket a company name and then creates and sells shares in that name, which people can buy and sell. So the ETF owns shares of all sorts of companies in the market. You do not – not directly. You buy and own shares in the ETF. Please note, because it will become critical later, that there are two markets and two sets of shares which the ETF sits across. The ‘primary market’ as its known is populated by ‘Authorized Participants’ which for the vast bulk of ETFs are the small club of global banks and brokers we have all heard so much about in the last few years. They buy or borrow (often from Pension Funds) the stocks and shares which will make up the ‘basket’ which they then put into a Trust. That Trust is then the issuer of the ETF. The Trust then creates what are called ‘Creation Units’, which are blocks of tens of thousand of individual shares in the ETF, which it gives back to the Authorized Participant.  The Authorized Participant then either keep these shares as an investment for themselves or sell them on the ordinary , or as they call it, the ‘secondary market’ to ordinary buyers who wants to own an ETF share.

A couple of points to note. The shares in the Trust which issues the ETF shares are very often borrowed from Pension Funds who are and remain the actual owner of the shares. The ETF shares issued against the ‘borrowed shares held in the Trust’ therefore do not confer actual ownership of the underlying shares so much as a ‘legal claim’ upon them. You can read more on this line in this paper from NASDAQ. You may wonder why ETFs have this complicated double layer of shares – those it borrows or buys to make the basket and those it then issues to investors – and the reason is tax. No cash is being exchanged, it is all shares for shares at every step. This means there is no tax  to be paid on any of the transactions.

However this tax efficient structure – which is the essence of the ETFs advantage over Mutual funds, presents what I think is the first overlooked problem.

Pinch Points in the ETF markets

Above I noted that as of the end of 2010 there were 2500 ETFs offered/sponsored by 130 companies, traded on over 40 exchanges. Which sounds like a healthy, broad based, liquid market. The Sponsor is the company that starts the whole thing, when it puts forward the plan for an ETF, gets that plan approved and manages it. However look a little closer and you find only 6 companies Sponsor and control  80% of the market.  Or to put it another way 80% of the market in ETFs globally, relies on the health and solvency of just 6 companies. Not a wide base then.But it gets worse.

Here is a list of the big 6 ETF sponsors and who owns them.

i Shares                                          = Blackrock. No 1 in ETF world with $670 B Assets Under Management (AUM).

State Street Global Advisors    = State Street Bank and Trust. $2 T  AUM. No 2 ETF with $283 B in ETF assets.

Vanguard                                      = Specialist ETF company based on Pennsylvania.No 3 ETF. $204 B

Lyxor Asset Management         = Soc Gen. with €85 B AUM in 1688 funds

db x-trackers                                 = Deutsche Bank

Powershares                                  = Invesco. A US company HQ in Atlanta but incorporated in Bermuda.

So of the 6 companies who are most of the ETF market  two are drawn from the ranks of the Global banks which have had to be bailed out.

However the Sponsors are not alone. The Sponsors rely for the heavy lifting of buying and selling the shares – market making in other words – on the Approved Participants to buy/borrow the stocks. Sadly, from the point of view of widening the risk base of the ETF markets, the Approved Participant are drawn from the same short list of global banks and brokers as are the Sponsors.

Here, for example, is a list of APs for an ETF called ‘Greater China’ run by State Street Global Advisors who are the second largest ETF manager in the world:

Merrill Lynch Far East Limited
Citigroup Global Markets Asia Limited*
Credit Suisse Securities (Hong Kong) Limited
Goldman Sachs (Asia) Securities Ltd
Morgan Stanley Hong Kong Securities Ltd
Nomura Securities (Hong Kong) Limited
UBS Securities Hong Kong Ltd


So 80% of the ETF market relies on the solvency of only 6 companies who sponsor and manage them. They rely in turn on the handful of Global banks whose solvency and stability we already know was in a crisis, and still largely is,  and remain totally dependant on Tax payer bail outs.

So how much stability do the APs bring to the ETF market? Well do you remember the ‘Flash Crash’ back in May last year when global markets suddenly experienced a crash in values that was caused by computer driven, High Frequency Trading? A study done by an ETF analyst revealed that 70% of the securities whose trades were cancelled that day were ETF shares. 70%! The study concluded that reason the ETFs froze and in doing so froze the markets was because the Approved Participants (the club of Global Banks and Brokers) froze. As the analyst said,

If those parties [the APs] are going to be paralyzed in the face of adversity, then the product [ETF] suppliers will have to qualify every statement they make regarding the liquidity and price efficiency of ETFs.

The article went on to point out,

Which, in other words, means the ‘flash crash’ may have shown ETFs to be particularly vulnerable in the event large sell-offs and liquidity lapses precisely because of their  structure’s dependence on market makers and authorised participants.

Precisely! A huge market reliant upon  6 sponsor companies who in turn depend for liquidity in their market, upon a just a handful of the same old banks and brokers, half of whom are themselves chronically insolvent bail out merchants. Now to be fair there are a larger number of other companies who also act as market makers in the sense of being very active traders but who are not APs and therefore do not contribute to the critical actual initial buying of shares to create the ETFs. Nevertheless they do contribute to the liquidity of minute to minute trading – not that they helped at all in the flash crash. So who are they, that we might find some comfort from them? You can find a list of UK market makers here. It contains 28 names. 15 are … the same large bailed out banks: Bank of America/Merrill Lynch, Barclays Capital, Commerzbank, Credit Suisse, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley, Nomura, Rabobank, RBS, Societe General, UBS and UniCredit.

Just like the Securitized mortgage/CDO market before it, the ETF market is constantly folded back on itself so that it relies always upon the same few players. At every stage the health, liquidity and operation of the ETF market is tied to the same very small number of very large players. And the flash crash clearly demonstrates how fragile and thin their liquidity providing and risk absorbtion actually is.

This theme of how everything is constantly tied back to the same players is what I will return to in part two, because it gets so very much worse. So far all we’ve really looked at are  just the general weaknesses of the plain vanilla market.

In the next part we will look at the huge rise in what are called ‘synthetic’ ETFs which are based not on owning shares but on derivative swaps contracts. We’ll look at who the counterparties are of all those derivative contracts. I’ll give you one guess.

Then we’ll look at how those risks have been increased by the creation of ‘Leveraged ETFs’ which promise 2 or 3 times the possible returns but at the cost of doubling or tripling the risks as well.

Then, in case anyone thinks that the Vanilla/Physical ETFs, based on owning the underlying shares, are, by comparison with Synthetic ETFs, not really a problem, we’ll look at how the physically-based Vanilla ETFs increasingly lend out the shares they ‘own’ in order to make more money.

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59 Responses to ETFs – The Next Accident Waiting to Happen?

  1. John Souter May 3, 2012 at 12:01 pm #

    David – I admire your perseverance.

    This is another example of the surreal alchemy of wealth extracted from nothing other than a manipulation to create a ‘market’ by permutation on an existing market without the restraint of having to invest in the existing market – in short an each way bet on a one horse race.

    Me! I’m developing an appetite that favours eating carrion.

  2. StevieFinn May 3, 2012 at 12:07 pm #

    Hi G

    Doesn’t sound like an accident to me, just another way to suck the rest of us dry. I think it kind of ties in with this article: The basic premise of it being that there will be no apparent big collapse, as there wasn’t at the end of the Roman empire, just a slow downfall & gradual deteoriation. Meanwhile the elites will further feather their nests, using ETF’s & other weapons of mass financial destruction, while the rest of us fade slowly as to almost make it appear as the new normal.

    Unless of course, people wake up.


    • Golem XIV May 3, 2012 at 12:13 pm #

      Hello Stevie mate,

      It’s the ‘waking up” I’m hoping and working for.

      The elites are riding high above us…but are doing so in The Hindenburg. And I have a match!

      • StevieFinn May 3, 2012 at 3:51 pm #


        I like the sound of that match:

        May the resulting conflagration fully match your ambition.


        Know what you mean, RTE news were caught out lying the other night regarding future IMF loans, but only after having sown the seed & of course like the rest of them, they consider themselves only accountable to whoever is throwing them bones. Perhaps the whole mainstream political establishment has to be fully discredited before things can change, behind the media veil they are doing a good job of it, seemingly uncaring or ignorant of the fact that there will be some pretty nasty chickens coming home to roost.

        Will try & find some of your comments, when I get a minute, bet you are giving them hell. Fair play.

    • Mike Hall May 3, 2012 at 1:30 pm #

      Stevie, that’s my take on it. Been scribbling away madly making comments about Ireland’s upcoming referendum. A ‘no’ would really, I hope, help to wake people up. But the Orwellian PR & scare mongering for a yes vote (naturally all main parties in favour) has to be witnessed to be believed.

      (journal.ie mainly, occ. Irish Times & Irish Indy if you’re interested, linked to my FB id.)


      As I was reading down, I was saying to myself, ‘where’s the leverage, the casino always requires it…’

      Sure enough, it’s there. Looking forward (if that’s the right expression) to part two. Thanks as ever for keeping us informed 🙂

      There’s only going to be one answer to this. As Wray, Black & many others say, we need to stop 95% of what the financialised economy leeches do.

  3. kunjani May 3, 2012 at 1:45 pm #

    Is this another type of infinite hypothecation relying on a single beneficial owner but renting out the same asset any number of times and creating what appears to be tradeable assets on potentially infinite debt? A new ponzi?

    • Golem XIV May 3, 2012 at 1:52 pm #

      Hello kunjani,

      Welcome. I haven’t seen your name before. If I have missed it then apologies.

      Part of it certainly is as you describe it. Actually more than one part. As Mike Hall says the leverage that comes through derivatives , rehypothecation and the like is always there somewhere.

    • TheNoseyMole May 4, 2012 at 3:13 am #

      Sounds a bit like fractional reserve banking….

  4. Joe R May 3, 2012 at 2:29 pm #

    Great piece Golem.

    This is not directly related – it`s a current an article from `comment is free` on the Guardian dealing with recent energy nationalisations in Argentina and Boliva. Your `main players` turn up there too, in the background playing with deriatives as usual.


    I have in the past here complained about the British media`s general inaccuracy in relation to Hispanic content articles. Well, this matter is different it seems, the Guardian article above is well researched and argued while pillars of the Spanish media ( e.g. El Pais, La Vanguardia ) are busily misleading their population with nationalistic drumbeating!

    • CArratiaM May 3, 2012 at 5:26 pm #

      Thanks for the link Joe R. Nice confirmation that sovereign states don’t have to be subdued by the financial cartel. I wonder about the implications for the spanish debt. Rajoy was very upset when Argentina nationalized the 51% of YPF, but they are much more calm now with Bolivia.

      In case some may need an historical background on the argentinian case, I post again a documentary with the looting of the argentinian state during the 90s


      • Joe R May 3, 2012 at 7:13 pm #

        Great – its long though!

        And Bolivia have agreed to pay Spain off –

        I think Spain are scared others will folow suiut and don’t want to shout anymore?!?

        • CArratiaM May 4, 2012 at 6:56 pm #

          Yeah it’s pretty long that one, kept me up until very late a couple of weeks ago when the YPF issue came to light.

          I guess they are indeed scared at the spanish government… and they may have also realised that they can’t really do much to avoid it now… who knows…

      • Wirplit May 19, 2012 at 2:13 am #

        Thanks for that link to the film CarratiM.. its great and I had not seen it before….what happened in Argentina is something everyone should be aware of. Direct parallels with a lot of what is happening now.

        • CArratiaM May 20, 2012 at 1:21 am #

          Great that you saw it and liked it Wirplit!
          when I first saw it I also got the impression that everyone should be aware of what happened. Glad to contribute.

  5. CArratiaM May 3, 2012 at 3:37 pm #

    Golem, great to see you back on the unmasking of the leeching techniques of the financial wannabe-alchemists. They have been selling the myth of growth and wealth production by “smart” money movements, but we know money doesn’t reproduce itself. Thanks for unveiling the machinery underlying the big scam.

    As Mike Hall was suggesting, there has to be some huge leverage there… avidly waiting for part two.

  6. Jim M. May 3, 2012 at 4:26 pm #

    Chuck Prince famously remarked, vis-a-vis the financial markets, As long as the music is playing, you’ve got to get up and dance

    I guess if the band starts to tire we just get us a new band? Maybe make one out of the distressed remains of the old one?

    Repaint & Re-package… that’s the way forward!

    It worked before… it might just work again!

    Perhaps one of our wild-eyed libertarian friends could arrange a cull to reinvigorate the moribund banking bloodstock?

    You busy at the weekend, Gary?

    • Golem XIV May 3, 2012 at 4:50 pm #

      Now, now. Play nice.

      • Jim M. May 3, 2012 at 5:07 pm #

        Shame on me! 🙂

    • Gary May 3, 2012 at 5:14 pm #

      This “wild-eyed libertarian” would have ensured that there would have been not one derivative peddling bank at the dance. They would have been buried by the free market 15 years ago. I keep saying much of the same thing. You keep failing to connect the dots. 🙂

      Sound money = no derivatives = no etfs.

      Between 1948 and 1971, during the Bretton Woods gold standard period, there were no derivatives to speak of.

      • CArratiaM May 3, 2012 at 6:15 pm #


        I would suggest you do a google search on “bitcoin derivatives”…

        • Gary May 4, 2012 at 9:25 am #

          Sound money system does not mean that you cannot write derivatives, you can. Sound money means that if you leverage yourself up to the hilt with derivatives, with insane leverage people may not want you as counterparty and normal market fluctuations will wipe you out. You will go out of business.

          When the govt steps in and offers up taxpayers to guarantee your business no matter how many derivatives you write and no matter how insane your leverage, then you get too big to fail.

          Remember a sound money is more than just the type of money, it also requires a free market. Gold only tracks real interest rates in a free market.

          • CArratiaM May 4, 2012 at 6:43 pm #

            Yeah, sound money wont prevent them stealing, they will just steal from a finite bucket… they could still get away with it.

            Anyway, from the discussions in Vulturecrats there are still some basics I don’t understand about the gold standard
            (sorry all guys, not that I wanna revive the whole argument but I’m truly curious…).

            So, under a gold standard, a certain amount of gold is supposed to back the currency, so that at any time one could exchange one currency unit, say peso, by a fixed amount of gold. How can there be a free market of gold then??

            If gold in the market is more expensive than the standard, what prevents me from changing pesos by gold, sell the gold in pesos and change’em back to gold and so on? I guess no-one will buy me the gold then, so in practice the gold price is fixed by the standard, it isn’t free market at all, is it?

            Have I got something wrong here?

          • Mike Hall May 6, 2012 at 1:55 am #

            @ CArratiaM

            Under a gold standard, gold can no longer ‘float.

            One of the biggest problems with it is in foreign exchange transactions.

            Under Bretton Woods, the countries party to the agreement effectively pegged their currencies together. In reality, all pegged to the US dollar, since it was the dominant economy by some margin. Trade imbalances built up & became impossible to balance because currencies/gold holdings couldn’t adjust without wrecking their own economies. This is why it fell apart. There are parallel problems with the Eurozone system. It is partly why the crisis here is worsening rather than merely stagnating in UK, US etc.

            There is no chance whatever that the world will return to a gold standard even if it had any merit for a single country. Global trade & FX would collapse. Unlike such heterodox approaches like MMT, it has been debated massively thru’ the history of economics. It lost the debate years ago. It has no serious body of support, for good reason.

            It’s appeal is limited to a narrow group, typically small (ish) investors, who desire a fully liquid store of value guaranteed in perpetuity. There never can be such a guarantee of security for the majority, but the goldbugs clearly believe they deserve it. As we’ve seen, they have little concern for whatever else happens in the world. The nature of the financialised economy is big fish eat little fish in the ‘bust’ phase. The little fish did ok in the ‘boom’ phase, jumping on the extraction bandwagon. Now the bandwagon’s stopped & some got burned too, they’re springing up everywhere complaining.

          • CArratiaM May 6, 2012 at 1:08 pm #

            Thanks a lot for your answer Mike Hall.

            So it is indeed as it looks like… it looks like a rat, smells like a rat, acts like a rat… what could it be?? Gold price is indeed fixed under a gold standard. Paradoxical from free marketeers.

            It seems indeed artificial to constraint the mean of exchange (money) to the existing amount of a material resource (gold) whose intrinsic value is unclear to me. This would require to artificially and dramatically increase the value of gold, limiting its use as a commodity and limiting the amount of money.

            By the way, interesting remark about “a fully liquid store of value guaranteed in perpetuity” being impossible for the majority.

  7. ch-ch-changes May 3, 2012 at 7:00 pm #

    Ignoring the historical inaccuracies for a mo, this sounds like a banksters version of “let them eat cake”

    But not as good as the Hindenburg analogy 🙂

    Sadly London remains the epi-centre and the UK has by far the biggest reliance on these “services” within GDP, so we have big changes to come. Given that even Merv has started stressing the urgency of the need to separate retail from “investment”, I asssume he’s noticed there are a few people with matches out here in non banking non Wizards of Oz land.

    This at least is one area we need to put pressure on – the more isolated the investment banks are, the less collateral damage we’ll shoulder.

  8. johnm33 May 3, 2012 at 7:57 pm #

    Midas eventually begged for his gift to be taken from him, and was allowed to wash his hands of it in the r.pactolus where the sand turned to gold [electrum]. After this he turned to the love of nature. http://charleshughsmith.blogspot.co.uk/2012/05/we-are-not-powerless-resisting.html
    But more to the point this looks more like a bookmaking, bookeeping licence to print money, since all the trades can be entered into the computers and gamed faster than any fund manager can think, and if anyone tries to hft back, freeze, with fees on top who needs icing or cherries.

  9. Pilotfish May 3, 2012 at 8:21 pm #

    I don’t own ETF’s and I didn’t participate in the saving and loan bubble, or the dot com’s, houses etc. and I was still effected by the blow back each time, so finally in 2008 started reading about our monetary system that makes this all possible. I’m convinced we need a world wide market place gold standard that is not controlled by governments. With that said back to the world we live in and your article this is the second yellow flag article I have read on ETF’s good article and thanks for the insight. Your article needs to be shared on as many blogs as possible because the mainstream outlets won’t. I do have a account at Vanguard and wonder how many of my individual stocks and bonds are at risk as well because I believe small amounts of stocks and bonds are bundled and held in house or held jointly with other firms for better liquidity. If ETF’s are at risk how safe is any holding in the paper markets at these or any large firm due to counter part risk that is systemic. MF Global comes to mind and the lack of government prosecution reinforces my belief that we are on our own and contract law will not be enforced by the government. The whole house of cards is at risk the why I see it.
    Thanks again for your article.

  10. Yakima Kanutt May 3, 2012 at 8:53 pm #

    I recall a time, could be 20 years ago, when ? (might have been Sunday Times magazine pre-Rupe, or even Time Out) did an article about the size of the UK pension funds, and how they dwarfed the market. At that time, it was British Rail and the Miners, and their fund managers scared the bejeezus out of the City.
    Now, I suspect that the Pension Funds still pretty much drive the entire market; everything else is just froth and invented paper. If you could get some regulatory discipline into the way these guys are suckered into investing (sorry, looting) your pension savings by the investment banks, then I reckon all this fraud could be brought to account, pretty much overnight. *

    So how do you get Parliament, or Merv. or whoever is protecting the punters interest these days, get stuck into this?

    * Unless folks stop paying their taxes, and take to the streets; and we have seen from Ireland -inconceivably- that there is almost no limit up with which people are prepared to put……………. I thought I understood how the world worked, but not a bit of it.

  11. shah8 May 3, 2012 at 10:04 pm #

    Right now, I think ETFs are part of a portfolio of products that is an attempt to siphon cash out of the economy in favor of large financials. The main indication I think it’s so, is the large stockpiles of oil and other commodities that don’t get sold (thereby lowering the prices). The stockpiled oil is used as collateral, via ETFs and other instruments, and is only sold at very high prices, and stockpiled in tankers otherwise.

  12. patma2003 May 3, 2012 at 11:15 pm #

    This particular blog entry will be worth returning to if this eventuates. Great write up. It probably sounds pretty sad, but I deeply hope some more financial chaos of their own creation is wrecked upon these maggots, something so bad they will have to ask for more wrapping paper to repackage the same shit from a different bucket. It’s a massive task continually redecorating human faeces.

    You kick a dog long enough…

  13. Roger May 4, 2012 at 5:58 am #

    Great Blog Golem thought provoking as ever.
    On Gold Buggery and on the objectification of money in general this from a Footnote to John Ruskins Unto this last.

    3. The disputes which exist respecting the real nature of money
    arise more from the disputants examining its functions on
    different sides, than from any real dissent in their opinions.
    All money, properly so called, is an acknowledgment of debt; but
    as such, it may either be considered to represent the labour and
    property of the creditor, or the idleness and penury of the
    debtor. The intricacy of the question has been much increased by
    the (hitherto necessary) use of marketable commodities, such as
    gold, silver, salt, shells, &c., to give intrinsic value or
    security to currency; but the final and best definition of money
    is that it is a documentary promise ratified and guaranteed by
    the nation to give or find a certain quantity of labour on
    demand. A man’s labour for a day is a better standard of value
    than a measure of any produce, because no produce ever maintains
    a consistent rate of productibility.

    On The gold Standard or return to such I say be careful what you wish for the larger plan is probably for a Carbon Trading Based currency with little or no regulation of polluting industries outside of however their Carbon output is measured. Capitalist Solutions just do not do Externalities!

    For The Gold Buggers ( Oooh er missus) and others.


    • Gary May 4, 2012 at 10:44 am #

      I spend 2 years of my labour lovingly making a buggy whip by hand that I am unable to sell because nobody has any use for it. That labour does not have the same value as that of a person who spends 2 years creating a business that makes heart machines that are much in demand that saves lives and employs many others.

      Marx premise of labour value was wrong. Everything that flowed from that false premise is also wrong.

      • Roger May 4, 2012 at 11:43 am #

        Gary I am sure it appears so to you and you are welcome to your conclusion. I wish I could have such certainty as you in some ways although I equate absolute cwertainty with ignorance and I do not wish to be ignorant or closed to the absolute certainty that in most sets of circumstances in the infinite universe most of my perceptions are probably false.

        • Jim M. May 4, 2012 at 2:09 pm #

          On an earlier thread one of our regulars (John Souter, I think.) made this pertinent observation;

          “… certainty backed by assumptions, generally makes fools of us all

          Have you actually read Marx, Gary?
          I’m no dyed-in-the-wool Marxist, but I am confident that Marx’s contribution and significance in the field of economics extends beyond the Labour Theory of Value.


  14. backwardsevolution May 4, 2012 at 8:17 am #

    David – excellent, excellent post!

    One of the best sites I used to frequent (the fellow has now stopped writing, as he’s too busy with his new endeavour) posted a few articles on ETF’s. He said:

    “The Truth About 2X, 3X and 4X ETF’s”

    BETTING the market using these vehicles is DANGEROUS. You should consider them worse than going to Vegas and betting on red – seriously, they are not worth the risk unless you REALLY, being serious with yourself, know what you are doing. If you do, then you know to use these only for VERY SHORT time frames, here’s why…

    Let’s use SRS, the 2X inverse of IYR, the commercial real estate fund as an example. Let’s say that two years ago you thought that commercial real estate was a disaster waiting to happen and so you decided to use SRS to bet against it. Well, if you bet against IYR you were 100% right, but if you used SRS to do it you went BROKE in the long run. Yes, some people made money on the WILD swings, but most gave it right back. Huge swings occur because of the math of compounding DAILY numbers… So that, you may be up over a few days, but then it corrects 5%, and then another 5%, and then another… but you would not have lost 15%, you would have lost WAY more than that because the numbers compound. Also, these ETFs have HUGE fees and “slippage” that KILL their performance over time. You WILL lose if you gamble with them too much.

    Below is IYR with an SRS overlay, 2 years. Note that at the beginning of the chart that IYR is at $170 and that SRS is at $100. If you bet against IYR using SRS and held, you would have gotten the direction correct as IYR is now worth only $42, A HUGE 75% PLUNGE, and YET your “investment” in SRS is only worth $8.92!!! That means that despite being RIGHT, you LOST 91% of your investment!!!

    I’m WARNING everyone here about these, they are the house and they are going to rob you blind, get it?”

  15. backwardsevolution May 4, 2012 at 8:30 am #


    “Now then, if you wish to bet against the market using single inverse ETF’s, that’s great, but again, they are not LONG term, buy and hold instruments. The inverse relationship will NOT be one to one over the long term, so that if the market moves down 20% over 4 months, you will likely NOT make 20%. You must know how these things work if you are going to gamble with them.

    Also, if you’re betting on a market meltdown, be aware that these are derivatives and that at some point there may very likely be counterparty issues.

    There are certain times and applications where they are appropriate for the right people. They are not for everybody, please be careful.”

    I remember a very bright blogger decided he was going to get into ETF’s, and every few days he would rant and rave about his investments. Even though he was correct and he was only dealing in regular ETF’s (not leveraged), he was losing his money. He was either going backward when he should have been going forward – or – his gains were not what they should have been. Other bloggers had similar results.

    Karl Denninger (who is very good at math) has had articles on ETF’s as well. From what I remember, he said they are not to be fooled with long-term – only for short-term plays. They are rigged to take your money. I’ll try to find one of his articles on ETF’s.

    • Golem XIV May 4, 2012 at 2:32 pm #

      Karl is very good I agree. Any article you find of his please post us a link. Thank you.

  16. keekster May 4, 2012 at 11:28 am #

    Great article as always David. I’ve come to the conclusion that beneath all the superficial complexity, its all very simple. The financial system does not generate wealth. Its the real economy that does, on the backs of our labour. The financial system, and all its offshoots, are simply tools for extracting wealth ‘rent’ from the rest of us. And very effective they are too. I suspect Dimtry Orlov is right. The system will implode regardless of our ‘protest’. Our best means of protest is to try and withdraw as much as we can, ie dont use banks, or credit where possible, instead cash, gold, credit unions etc. Remove our collateral from the system, and it fall. Instead we should invest locally, so the money says local, rather than going into the system. Well as best we can.

  17. patma2003 May 5, 2012 at 12:47 am #

    Is off topic, so will post here. Good to see the Eastern viewpoint of the recent INET get together in Berlin.

    Andrew Sheng, the chief adviser to China’s Banking Regulatory Commission, is President of the Fung Global Institute in Hong Kong. Previously, he served as Chairman of Hong Kong’s Securities and Future


  18. MacB May 5, 2012 at 1:34 am #

    Patma, thanks for the link and I think the paradigm shift is pretty well recognised now, though I particularly like the term ‘creative destruction’. This surrounds us but is something that should be within the scope of the system to cope with. But it’s a concept that most people can instinctively grasp, they may not like it but they recognise why and how technology and innovation destroy as they create.

    Golems last two articles, and several others he has written, give a clear indication of why the system is failing to cope. He has been highlighting examples of technology and innovation that only destroy, they have no creative element. Elaborate and complex as all these schemes have been, and are, it’s becoming clearer that there has never been a creative component. Or at least the only creative bit has been the scam of extracting ‘rent’ while passing the buck on the risk.

    Considering the level of complexity involved, the shroud of secrecy that stubbornly refuses to part and the pathological behaviours that seem uncontrollable, I can’t see any fix that doesn’t require full seperation. We need a banking system fully functioning and with the necessary level of backing to ensure trust. A Glass-Steagal Mark II, maybe beefed up a bit, has to be on the table. It was a widely mooted response to the initial crisis and would seem even more of an essential now.

    Done right then we can forget about worrying about what exotic financial instruments are being invented and which of the scumbags are shafting or being shafted. You only need to know the house rules if you’re planning on playing in the casino.

  19. Dave Harrison May 5, 2012 at 12:04 pm #

    Readers may be interested in a non-technical piece from April 29th on how a temporarily falling gold price may indicate troubles in ETF-land.


    • Gary May 6, 2012 at 12:23 pm #

      I think Dave is correct. If you don’t have physical gold in your hands, then you only have a fractional paper iou of gold, and that means you may have nothing. Be warned.

  20. Bron Suchecki May 7, 2012 at 4:57 am #

    Very good article as few discuss the fact that ETF holders are captive to the exchanges the ETF trades on and the APs to make a market.

    This is the reason I included the ability for retail investors in the Perth Mint’s gold ETF to redeem their shares for any of our coins or bars or for cash directly with the Mint – a necessary safeguard should the ASX close or our market maker fail to perform.

    The problem is that people who build financial products do not think about extreme failure situations and design their products to be robust for such situations.

  21. patma2003 May 19, 2012 at 2:55 am #

    I’d just like to comment that not all libertarian fiscal thought screams for a gold standard. Far from it. The association is just flavour of the month.

  22. Flight Gear April 25, 2013 at 10:45 pm #

    I wouldn’t have any idea the way I found themselves the following, even so considered that post once were great. I do not fully grasp the person you could be even so undoubtedly you are going to a well-known tumblr any time you are not witout a doubt. Regards!


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