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Here's something we all should be worried about....

Senate pays lip service to ETF issues
By Charles Jaffe
cjaffe@ marketwatch.com
In Washington these days, politicians believe they can get away with doing nothing, so long as it looks like they are doing something.

That's clearly what was happening last week when the Senate held a hearing to discuss issues in the world of exchange-traded funds.

On the surface, it looked like Congress wants to do something to address public concerns that ETF trading is making the stock market more volatile, or that supercharged ETF products are dangerous for consumers.

And while the testimony made news in the investment world last week -- for reasons you will see in a moment -- the obvious truth was that no one on Capitol Hill really wants to tackle these issues.

The proof? Only one senator, Jack Reed, D-R.I., chairman of the Senate Subcommittee on Securities, Insurance and Investments, bothered to show up for the hearing.

While it's not uncommon for politicians to flit from one meeting or hearing to the next, popping in to ask a question or two and get their name on the record, that didn't happen this time, virtually guaranteeing that the whole exercise amounted to sound bites that will accomplish nothing.

What the senators missed by not showing up was some pretty good information on the industry, plus at least one wretchedly bad idea for "fixing" a perceived problem.

Average investors, unlike the politicians who represent them, should care. First, industry types addressed several common concerns that politicians and the public has about ETFs, such as that they make the market more volatile or that the use of ETFs and indexing is slowing the creation of stocks in this country.

The first criticism has been loud and regular since the Flash Crash of May 2010, even though every reputable academic study has shown that the idea has no merit.

While most people think that ETF trading involves moving the underlying securities, that's false in most cases. Instead, amid the rapid trades, buyers and sellers are matched up; in more than 80 percent of the trades in the most popular ETFs, shares move from one investor to another and there is no need to buy or sell any underlying securities.

Thus, an ETF can rack up big trading volumes without necessarily increasing the trading volume and frequency of the underlying stocks. "At the hearing, three out of the four key people testifying talked about how ETFs are not creating volatility in the market," said Scott Burns, director of ETF research at Morningstar Inc. "People being really freaked out and panicky is what's creating volatility in the market."

The whole idea of ETFs somehow curtailing initial public offerings is silly on its face.

ETFs track indexes, and indexes need those underlying securities to track the market.

If being part of an index helps to get a stock attention and notice, then the proliferation of new and different indices -- most being created these days expressly to serve as the basis for an ETF -- would be a reason for management to be confident that if they go public, they can gain some traction.

The bigger ideas to come out of the Senate hearings were shared by BlackRock, which called for uniform labeling standards. BlackRock, the world's largest provider of ETFs through its iShares unit, wants the ETF label to apply only to certain funds; leveraged, inverse and derivative-laden funds would have to be described as some sort of exchange-traded "product."

Tom Lydon, editor of ETF Trends, said this is like trying to say that because Ferraris can drive 180 mph, they shouldn't be allowed to be called "cars."

What the BlackRock labeling proposal ignored is that every different type of investment that falls under the loose label of ETF -- exchange-traded notes, grantor trusts and more -- is basically the same when the public goes to view it.

They click on a quote page, they get details; they click to trade and it trades, no matter which type of exchange-traded product label you stick on it. Hearings make for good populist rhetoric, but not great regulation.

What's more, the approach taken by both the Senate and the Securities and Exchange Commission is patchwork and Band-Aid, rather than blanketing and cure-all.

If Congress and regulators are worried about derivatives in ETFs, they should not be approving one flavor of fund and delaying approval for another; they should hold up the registration of new products and shutter the existing ones until they can get their answers.

"What they are really worrying about is that if we ever have a true run on the marketplace like we had in 2007-2008, the derivatives exposure we have in ETFs today could lead to major collapses," said Geoff Bobroff, an industry consultant in East Greenwich, R.I.

"If they think certain types of ETFs are a problem, they need to shut them down until they figure it out, not come up with ideas about labels. ... What you saw ... is that Congress is interested in talking about these things, just not in doing much about them."

Charles Jaffe is a columnist for MarketWatch.





Read more: http://www.star-telegram.com/2011/10/29/v-touch/3483234/senate-pays-lip-service-to-etf.html#ixzz1cZ5Nv07F