Wednesday, February 10, 2016

10/2/16: Ponzi Schemes? Bah! We've Got an ETP Problem, Roger...

An interesting story that Mark Markopolos of Madoff fame, via BusinessInsider, apparently unearthing a bunch of new Ponzi schemes on the Wall Street to rival Madoff's:

Several interesting and obvious things in the article. Assuming, of course, Markopolos is not talking about the Ponzi of all Ponzi Schemes, the 'fiat money' printers at the Central Banks. But one worth a note, the little piece relating to ETPs (Exchange Traded Products) that allegedly polluted the previously relatively clean universe of U.S. listed ETFs with the European disease of synthetics.

The crux of the issue is contained in this letter:

Choice quotes:

"With the mortgage-backed securities crisis... it was the bundled, flawed mortgage products that became a significant contributing factor to the negative financial events of 2008/2009. Some ETPs contain very similar characteristics to the illiquid mortgage-backed securities. Other ETPs are based on very risky trading and settlement processes that can produce systemic challenges to the ETP industry, thus the financial markets."

Dire stuff. We get more: "There has been an exponential growth rate in the number of ETPs since the financial crisis. Unfortunately, unlike mortgage-backed securities, which were sold to more professional investor classes, ETPs have been marketed on a large-scale to retail investors, their mutual and pension funds and financial advisors are advocating the products to even their retail customers." It's grannies and pensions, not Lehmans & Bears that are now at risk. Congratulations, folks: financial engineering, having plundered taxpayers and savers is now munching through retailers, aka ordinary folks, directly.

Worse: "...the most active ETPs are based on the important components of the U.S. capital markets, i.e. S&P 500 securities. A collapse or disturbance caused by these products could strike directly at the heart of the U.S. financial system during the next financial crisis through blue chip securities." Munching through ordinary folks requires levering more risks into core equities and asset markets too. So if you haven't bought the Killer White of risk yourself, via links to underlying equities and other retail assets,  the Killer White of risk bought you anyway.

What's the problem if they can just sell underlying and clear off the decks? Ah, that 'selling the underlying'. "The vast majority of ETPs have very low levels of assets under management and illiquid trading volumes. Many of these have illiquid underlying assets and a large group of ETPs are
based on derivatives that are not backed by physical assets such as stocks, bonds or commodities,
but rather swaps or other types of complex contracts."

Hello, Kitty... no wait... Kitty is a rabid tiger! Back in 2011 I wrote about these types of funds in relation to the European investors here:

And the latest revelations are absolutely mirror image of the concerns raised in 2011: "Many of these products may have been designed to take what were originally illiquid assets from the books of operators, bundle them into an ETP to make them appear liquid and sell them off to unsuspecting investors. The data suggests this is evidenced by ETPs that are formed, have enough volume in the early stage of their existence to sell shares, but then barely trade again while still remaining listed for sale. This is reminiscent of the mortgage-backed securities bundles sold previous to the last financial crisis in 2008."

Garbage in. Balancesheet cleansed. You, retailer, holding the trash.

This can get very very ugly...

Note: in addition to the above letter, there are several other letters released by SEC detailing the problems in ETPs universe. Here are the links:

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