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35 Questions for the Fed about Leveraged and Short ETFs

Ron DeLegge

So, the Federal Reserve says that leveraged and inverse (short) exchange-traded funds (ETFs) could destabilize financial markets during periods of high volatility? Really? 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 - News) is current undergoing because of Bernanke & Co.'s various monetary experiments?  

Speaking of leverage, why is the central bank's debt-to-equity ratio higher today than Lehman Brothers right before it went bust? How can the Fed have the audacity to lecture anybody about the danger of leverage when it itself is overleveraged? And why do the largest U.S. banks (XLF - News) 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 about excessive leverage and risk taking in the $2.5 trillion opaque hedge fund industry? Doesn't that worry the Fed? Doesn't the hedge fund religion deserve priority attention compared to the much smaller and less significant $50 billion or so parked in leveraged and inverse ETFs? And besides that, what are the chances of another magnificent hedge fund collapse just like Long-Term Capital Management in 1998? What concrete steps, besides issuing press releases, has the Fed taken to prevent a reoccurrence? 

WATCH: Tips for Using Leveraged and Inverse ETFs

What is the Federal Reserve's definition of "market stability" anyway? Is it the $200 billion in mark-to-market YTD losses suffered by the Fed's Treasury bond portfolio due to the latest episode of rising interest rates (^TNX)? And what would happen if interest rates rose just four percentage points more? Could losses in the Federal Reserve's fixed-income portfolio top a trillion dollars? What kind of meltdown would that be? And could it lead to a central bank solvency crisis? Tell us, who at that hellish point would be on the hook for bailing out the Fed and its highly esteemed members?

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?" Never mind Trainor, are there any other desperate academicians (besides Tugkan Tuzan) who we can pay to craft biased and damning research?

Could it be the Fed's own definition of "market stability" - albeit a perverted one - 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 of this scathing 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? Besides that, how should we classify this report's inarticulate attempt to "educate" us about the potential impact of ETFs on market stability? Shall we list it under comedy or horror? 

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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