ETF Securities is launching an exchange for ETFs that includes a consortium of over 15 global banks and asset managers (see Hedge Fund Review article). The structure allows each exchange member to be able to participate in trading, market making, and index replication activities while allowing counterparty risk to be spread among multiple exchange members. By concentrating liquidity in a single location, ETFs that would normally be unavailable due to low demand and liquidity issues, can now be created and used for more specific purposes, such as hedge fund replication, without the same trading and credit worries. Certainly an interesting idea during a time when many are concerned about those on the other side of the transaction, especially when specialized, low liquidity securities are involved. This may be one way to help reduce both counterparty and liquidity risk for those researching and implementing hedge fund replication products.

Just yesterday I wrote a post about how the IMF is predicting that toxic debt will increase to nearly $4 trillion worldwide. Now, a recent report released by the Congressional Oversight Panel - those in charge of overseeing the TARP - indicates that $700 billion may be just the beginning in the U.S. (see ABC News article). To date, the TARP, Fed, and FDIC have set aside, lent, or spend more than $4 trillion.

New forecast from the International Monetary Fund are predicting that toxic debt will increase to nearly $4 trillion, due in part to the forecast of toxic assets in the U.S. rising from $2.2 trillion to $3.1 trillion (see Times Online article). Toxic assets across Europe and Asia will increase the total by another $900 billion. Given that "only" about $1.3 trillion has already been accounted for, the size of the money hole may be considerably larger than expected, requiring governments to bury more cash in an attempt to fill it up. As some have predicted (see Dealbook article), after the mortgage write-downs, banks will start unloading loans on the commercial side, and non-mortgage loans, such as auto and credit card loans, on the retail side. At some level governments are going to get spending fatigue and see increased levels of taxpayer revolt, or at least reach a level where saving the patient begins to bankrupt the caretaker and no longer makes sense.

There is an interesting article by Andrew Ross Sorkin over at the Dealbook blog (see article here), discussing how the FDIC is justifying its participation in the Public-Private Investment Program (PPIP). In effect, the FDIC is insuring the PPIP in the name of mitigating systemic risk. While the FDIC is not suppose to guarantee obligations of more than $30 billion, for the PPIP it is not considering total obligations, but contingent liabilities, or what it expects to lose - which conveniently, they project to be nothing. This form of logic essentially allows them to lend an unlimited amount of money. Yet under the PPIP plan, the public-private pool will be financed at a ratio of 6-to-1 public-to-private money, with half of the "1" coming from the private buyer, and the other half coming from the Treasury. With this debt being non-recourse and guaranteed by the government, the risk to the government (i.e., tax payers) would be significant and fully felt. In some ways, it appears that the program will either work wonderfully, or end horribly. Maybe I am missing something, but this sounds like as risky a leveraged bet as I have ever heard. Regrettably, this appears to be just another example of solving a problem caused by taking on too much debt and risk by, you guessed it, taking on too much debt and risk. Why does the term "double down" come to mind? I don't know about you, but I am hoping we hit 21. Otherwise, it may be a long bus ride home.

Vanguard is offering a small cap international ETF which tracks the FTSE Global Small Cap ex-U.S. Index (see Index Universe article). The fund considers both developed and emerging countries. While both "small cap" and "emerging" hint of increased risk, the ETF holds 2,100 different companies, providing broad exposure. The ETF also has a relatively small expense ratio at 0.38%, providing an inexpensive and diversified way to take on some international and emerging growth exposure.

In the wake of a nice bear rally, the SEC is once again discussing the reinstatement of the uptick rule, or some version of it (see Financial Times article). The rule was abolished in July 2007, but now various politicians are writing to SEC chairwoman, Mary Schapiro, asking that the rule be reinstated in order to produce an “unambiguous commitment to promulgate and enforce regulations that put an end to naked short selling”. Of course, naked short selling is already not allowed. While selling on a down-tick may have facilitated naked short selling, reinstating the uptick rule will not by itself rid the market of naked short-sellers. Enforcement of current rules might actually be the place to start. Until the SEC gets serious about investigating delivery failures, naked short selling will continue, regardless of changes in the uptick rule.

In addition politicians, the largest US exchanges have also recently written to the SEC asking that some version of the rule be put back into place, and further suggest that the new rule only allow short selling to be initiated by posting a quote for a short sale order that is priced more than the prevailing national bid. While such a change seems slightly different from the requirement of selling only on a new plus-tick or previous plus-tick (the current price being the same as the last, which was up), the change is significant. A value higher than the bid can still be below the ask. Not only are the prices lower than a plus tick (which is not that difficult to find for highly liquid stocks, even during a sell-off), selling between the bid and ask also makes the transaction less transparent. To make matters worse, the exchanges don't stop here, but also suggest that as an added precaution (guess for who), that a new type of circuit breaker be used that would initiate the rule only when the stock had a precipitous decline - defined as 10 percent. No more killing a stock in one or two days. Now it will take you at least 10 days. Not sure this is much of an improvement.

As for the motivation of the exchanges, you cannot really blame them for being proactive. While it is essential to keep the hedge funds and other drivers of order flow happy, helping to convince individual investors that it is safe to wade back in the waters will also be good for trading and revenue generation. I am sure that it is also hoped that any collaboration will make it more unlikely that the SEC will temporarily change the rules at a later date, selectively deciding what can and cannot be shorted. As for the SEC, they send the message that the days of the wild-west are over, and politicians get to take credit for putting pressure on the regulators and exchanges to look out for the little guy. Yet the changes will be ineffective at best - since naked short selling is not really directly addressed, and will most likely get worse given that shorting on a price higher than the bid is no improvement at all, but simply helps to mask the underlying transaction.

When I began to see the increased focus recently on finally bringing back the uptick rule, my initial thought was that if the rule was so vital, why has it taken this long to get back on the books? Looking at the latest collaborative effort, a little more delay might be in order.

A new proposed product from Macroshares will allow investors to purchase Up and Down ETF shares based on the movement of the S&P / Case-Shiller Composite Index (see WSJ article). Unlike some other similar ETFs, the proposed shares will not be backed by the physical asset, such as you might see with gold ETFs. Therefore, there will not be a specific artificial commodity bull market as the physical asset is bought to cover the demand for new shares (too bad for all those homeowners underwater). Here, the cash is put into government securities to ensure liquidity, creating a kind of zero-sum game as cash is moved from one account to another as housing prices, and the Case-Shiller index, move up and down in price. Obviously, if there is more demand for one type of share, this side of the bet is likely to trade for more than its net asset value, while the other side will trade at a discount. The zero-sum game structure also places a cap on profits since a positive move of 100 percent all but clears out the down shares, causing an automatic liquidation of shares.

While such a vehicle will get some attention given its tie in to the Case-Shiller index, not to mention offering a new and more liquid method for taking on housing exposure, it is likely that only a select set of builders and highly mobile executives on the coast who are looking to hedge their risks will find much use for this specific ETF (see article for past failed housing products). Speculators, of course, will be looking for significant daily liquidity before stepping their toes into the water. Time, and a potential housing recovery (or further bust), is probably needed before people will be encourage to bet with or against housing in this manner.