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"ETF Losses Today Were Far Beyond What The Most Sophisticated Risk Models Could Have Predicted"

Tyler Durden's picture


There was a time when portfolio insurance guaranteed that events like Black Monday would never happen. Then Black Monday happened precisely due to portfolio insurance. Some years later, the credit-driven housing boom made modeling of declining home prices at rating agencies (and everywhere else) redundant. Then the (first) housing and credit bubble popped leading to the biggest housing market crash in US history. Fast forward to today, when ETFs were supposed to be the "greatest thing since sliced bread" and providing an ultra-low cost alternative to mutual fund and other market exposure "for the people", were supposed to revolutionize investing. Until days like yesterday. To wit from the FT: "The losses for ETFs today were far beyond what the most sophisticated financial risk models could have predicated for worst-case scenarios," said Bryce James, president of Smart Portfolio, which provides ETF asset allocation models.

Turns out yet another cost-cutting, computerized contraption was only as strong as its weakest link: which in this case turned out to be a completely unexpected, Bernanke-driven bond market sell off, which led to unprecedented stress in the $2 trillion ETF industry.

More from the FT:

A wave of selling caused many exchange traded funds to tumble below the value of their underlying assets as a bond market sell-off caused stress in the $2tn ETF industry.


ETFs track baskets of underlying assets, such as emerging-market stocks or municipal bonds, but discounts widened sharply on Thursday as dealers struggled to keep up with the sell orders.


Emerging-markets ETFs were among the worst affected, as investors took fright that the end of Federal Reserve monetary easing would lead to outflows from developing countries.

Please welcome the ETF gates:

The selling also caused disruptions in the plumbing behind several ETFs. Citigroup stopped accepting orders to redeem underlying assets from ETF issuers, after one trading desk reached its allocated risk limits. One Citi trader emailed other market participants to say: “We are unable to take any more redemptions today . . . a very rare occurrence due to capital requirements we are maxed out on the amount of collateral we have out.”


State Street said it would stop accepting cash redemption orders for municipal bond products from dealers. Tim Coyne, global head of ETF capital markets at State Street, said his company had contacted participants “to say we were not going to do any cash redemptions today”. But he added that redemptions “in kind” were still taking place.

But don't worry: it's temporary: "Market participants described the heavy volumes and losses on Thursday as a rare occurrence"... although if it isn't "it could translate into further selling on Friday or early next week."


Then again, if the Plunge Protection Team - which was designed for precisely these kinds of interventions - does not step in, the entire ETF space could go up on a margin call musrhoom cloud.  Going back to Bryce James: "The falls violated risk tolerance levels for many investors and if they were leveraged at all they are likely facing capital calls."

So keep calm and buy. Or else the fake and artificial wealth effect gets it.

Also perhaps it is time to inquire: if Money Market Funds were the straw that broke the post-Lehman camel's back, will that dubious distinction be handed to the ETF product the next time the global financial system is on the rocks and needs just one spark for the final collapse?

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Fri, 06/21/2013 - 08:05 | 3678576 GetZeeGold
GetZeeGold's picture



Just paper.....just sayin.


They Sow the Wind, and Reap the Whirlwind

Fri, 06/21/2013 - 08:07 | 3678587 ParkAveFlasher
ParkAveFlasher's picture

Sneezes kill!

Fri, 06/21/2013 - 08:17 | 3678614 DaddyO
DaddyO's picture

Remember the old saying about sitting at the poker table not knowing who the patsy is...

It's you!!!

This game is so rigged even my children see through it...


Fri, 06/21/2013 - 08:40 | 3678668 jbvtme
jbvtme's picture

do your children have a newsletter?

Fri, 06/21/2013 - 08:55 | 3678728 Shooting Shark
Shooting Shark's picture

While it is not necessarily true that most children have newsletters, it does seem the most newsletters are written by children.  PROVEN WITH GEOMETRICLOGIC!1

Fri, 06/21/2013 - 09:05 | 3678773 mess nonster
mess nonster's picture

"The ability to purchase and redeem creation units gives ETFs an arbitrage mechanism intended to minimize the potential deviation between the market price and the net asset value of ETF shares." - wikipedia

So... how's that workin' out fer ya?

Fri, 06/21/2013 - 09:37 | 3678902 ebworthen
ebworthen's picture

"We are unable to take any more redemptions today."

"Do not worry."

Fri, 06/21/2013 - 10:13 | 3678989 Oh regional Indian
Oh regional Indian's picture

I feel there is a huge liquidity diversion cirsis straight ahead...




Fri, 06/21/2013 - 10:19 | 3679004 Richard Chesler
Richard Chesler's picture

hookers + college kids + blow + excel = sophisticated financial risk models.

Fri, 06/21/2013 - 10:43 | 3679068 Joe Sixpack
Joe Sixpack's picture

Just another opportunity to transfer large parts of the physical holdings of GLD and SLV to China as Clinton probably negotiated in 2009.

Fri, 06/21/2013 - 10:52 | 3679103 ebworthen
ebworthen's picture

The video linked there with Russel Brand is hilarious.

Brand running circles around the befuddled newsy anchors; and Mika Brzezinski becoming completely un-anchored:

Fri, 06/21/2013 - 11:45 | 3679331 Kirk2NCC1701
Kirk2NCC1701's picture

+1. Good one.

Turns out that Mila is not only a MILF, but a "shaft grasper". I think she had the hots for Russell. The body language was obvious.

The other two side kicks are just dingbats with a 'job' and good pay. Where do you apply?

Fri, 06/21/2013 - 08:59 | 3678747 DaddyO
DaddyO's picture

No, they've been taught to invest in tangibles, things you can hold close to you. They all do well in their areas of interest.

We should take their lead and do likewise, playing in these markets today is financial suicide.

Unless you're in the top tier like JPM or GS, it's just big fish gobbling up little minnows by the thousands...


Fri, 06/21/2013 - 09:38 | 3678887 LawsofPhysics
LawsofPhysics's picture

Likewise,  my children know the value of hard work and more importantly the value of the own labor.  They understand the importance of physical assets and a dependable tribe as well.


More than ever, fraud and corruption is the stauts quo, possession is the law.

The underlying fundamentals have not changed.  The world is awash in paper promises, and the liabilities and debt the needs to be serviced (or defaulted on) is still there and growing.

Fri, 06/21/2013 - 09:37 | 3678901 HedgeHammer
HedgeHammer's picture

LOL, That has to be the best comment I've seen in a long time. HaHa all charts are in color enhanced by Crayola.

Fri, 06/21/2013 - 09:49 | 3678932 Renewable Life
Renewable Life's picture

Of course they do, there on Facebook!! Published (updated) hourly no doubt!

Fri, 06/21/2013 - 08:31 | 3678646 Dr. No
Dr. No's picture

"Worst-case risk model"  Let see, the worst case of buying any stock is zero value.  So I assume their worst case risk model was zero value?  I guess I am not a "sophisticated" investor.

Fri, 06/21/2013 - 09:08 | 3678785 Joe Davola
Joe Davola's picture

Perhaps their Sophisticated Risk Models need to do do away with the sophistication and look at the underlying reality.

Fri, 06/21/2013 - 11:10 | 3679181 jerry_theking_lawler
jerry_theking_lawler's picture

isn't the 'worst, worst risk model' going short?? aren't the losses infinity??

Fri, 06/21/2013 - 08:06 | 3678583 Dr. Engali
Dr. Engali's picture

Damn that counterparty risk will get you every time.

Fri, 06/21/2013 - 08:09 | 3678593 kliguy38
kliguy38's picture

what possibly could one own that doesn't have counterparty risk that you can keep yourself?????

Fri, 06/21/2013 - 08:14 | 3678606 francis_sawyer
francis_sawyer's picture

a boat?

Fri, 06/21/2013 - 08:23 | 3678629 ArkansasAngie
ArkansasAngie's picture

If your bookie goes broke who do you collect from
Market confidence?
I truly hope those mf'ers get their comeuppance
Why do you think they call'em snake eyes?

Fri, 06/21/2013 - 09:06 | 3678777 mess nonster
mess nonster's picture

...but I lost my boat in an unfortunate gold accident.

Fri, 06/21/2013 - 09:24 | 3678852 francis_sawyer
francis_sawyer's picture

which explains how you came to be the 'mess nonster'...

Fri, 06/21/2013 - 10:38 | 3679051 screw face
screw face's picture

+1.......ummmmmm flotation devices....

Fri, 06/21/2013 - 08:16 | 3678611 insanelysane
insanelysane's picture

Awesome watching Dumberg tv and CNBS this morning.  All of the "experts", who for months were saying that the rally with new highs each day was based on fundamentals and not the FED, were bemoaning the fact that the FED was even thinking about reducing the amount of crack it has been bringing to the party.  Put me in a great mood for a Friday.

Fri, 06/21/2013 - 08:31 | 3678647 RSloane
RSloane's picture

Dr Bernanke states: The patient has no symptoms of disease, start her on a rigorous regimen of chemotherapy immediately!

Fri, 06/21/2013 - 08:35 | 3678653 fonzannoon
fonzannoon's picture

If I get any more bored I will  put together a bunch of clips of Bartiroma the last 4 months telling everyone "The fed is going to be there forever! They are not going away!"

and then this past week "Everyone knew the fed was going away. How could anyone say they did not know that!"

Fri, 06/21/2013 - 08:46 | 3678693 RSloane
RSloane's picture

Why isn't someone on CNBC screaming "The futures are off their highs!" as they do when they're off their lows? Propogandists often confuse themselves in the rush to subvert the truth. Bartiroma is so dense that she thinks what she utters is absolute reality, even if she contradicts herself on a daily basis. On the tier of incredibly annoying and stupid people at CNBC, she is second to Liesman and Cramer.

Fri, 06/21/2013 - 09:03 | 3678764 Hopeless for Change
Hopeless for Change's picture

You mean third?

Fri, 06/21/2013 - 09:05 | 3678770 RSloane
RSloane's picture

No. Liesman and Cramer are tied for first place.

Fri, 06/21/2013 - 09:40 | 3678911 ebworthen
ebworthen's picture

I vote for Liesman; Cramer at least knows what he is doing.

Fri, 06/21/2013 - 09:11 | 3678799 beachdude
beachdude's picture

I would say that "Beckie and Androo" on squawk box are even more annoying... virtually unwatchable. Mute cnBS and watch for Santelli.

Fri, 06/21/2013 - 09:23 | 3678847 RSloane
RSloane's picture

Ah yes Andrew. He presents himself as "for the common man" yet we have to listen to him bitch about not getting his kids into a pre-kindergarten program that costs 25,000$ a year per child. Clearly he should be entitled for first consideration because he's, you know, Andrew! and for the common man. The fact that he thinks that he is above "the common man" let alone identified a group as being "common" tells you something about his sense of entitlement.

Becky is there to blow job Warren Buffet regardless if he is on the set or not. She loves to quote him even when his flagship is failing. She is the dewy-eyed acolyte who must be thought of as "cute' because that type of adoration is so marvelous to see.

"Squawk Box" is like watching "Little Shop of Horrors" in that its so campy there must be a laugh or two in there.

Fri, 06/21/2013 - 09:12 | 3678802 Boozer
Boozer's picture

Please make the time for that project Fonz!  Sure plenty of ZHers would enjoy it.

That woman makes me sick.

Fri, 06/21/2013 - 09:14 | 3678810 fonzannoon
fonzannoon's picture

The only thing stopping me from doing it is knowing that Bartiroma and the rest of the crew will watch it and giggle while downing mimosa's by the pool this weekend.

Fri, 06/21/2013 - 09:28 | 3678868 francis_sawyer
francis_sawyer's picture

As soon as you posted that, a 'GONE SQUATCHIN' click ad came up... Hmmmmmmmmmm...

Fri, 06/21/2013 - 08:17 | 3678613 NoDebt
NoDebt's picture

Yeah, I found it interesting the comment about so many calls to take delivery of the underlying assets of the ETF.  Only the big boys can make that kind of call to an ETF.  I believe that's called a "redemption-in-kind" (somebody please correct me if I'm wrong about the terminology).

I recall a big one like that was made on JNK a while back (but not during a crisis).  Somebody built up a big position in the ETF and then called in about $650MM of the underlying bonds as a redemption-in-kind.  I thought it was a savvy move because it cloaked who was actually putting on a big high yield bond positon.  Just looked like the ETF doing their index thing, then the ultimate buyer got the underlying bonds without tipping anyone off they were even in the market.  And, of course, owning the actual bonds they could then sit back and just run them to maturity if they chose to (which would not be possibly by continuing to hold shares in JNK)

Fri, 06/21/2013 - 08:48 | 3678700 Dr Benway
Dr Benway's picture

The fact that they are offering in kind redemptions but not cash redemptions is a pretty clearcut indication that State Street can't sell the underlying assets at the price they are booked, or fears doing so could spark a vicious circle by crashing the underlying asset price.

I wonder how many of these ETFs are deliberately mispriced, given issuers would have an interest to inflate its prices during period with net fund inflows. Why would tracking products ever have "unexpected losses", if their construction is not faulty?

Fri, 06/21/2013 - 08:57 | 3678736 GMadScientist
GMadScientist's picture

Just the kind of tripe you'd like to have handed to you instead of cash, right?


Fri, 06/21/2013 - 09:35 | 3678895 LawsofPhysics
LawsofPhysics's picture

Bingo.  "Mark to fantasy" forever!

Fri, 06/21/2013 - 10:42 | 3679064 NoDebt
NoDebt's picture

Agreed- some of them are big enough to do the tail-wagging-the-dog thing.  Would you like the underlying assets at current quote, or would you like us to flood the market and drive down the price at which we sell them to give you cash?  Decisions, decisions.

Fri, 06/21/2013 - 08:07 | 3678588 NoDebt
NoDebt's picture

The more complex they make the plumbing the easier it is to stop up the drain.   - Scotty -

Fri, 06/21/2013 - 08:19 | 3678619 Hmm...
Hmm...'s picture


the problem is that these financial products are too complicated to understand, much of it by design. (Big Finance profits mightily due to manufactured opacity of the marketplace). 

worse: BigFinance is overly connected, again in opaque ways. 

Now, nobody can understand what the heck is going on.  That's why I stopped investing in the stock market once the first crash occurred.  I sleep much better regardless if the market is at 666 or 1500.

Fri, 06/21/2013 - 09:05 | 3678772 kridkrid
kridkrid's picture

Complicated financial products are a symptom, not the cause. And they aren't so much complicated as they are criminal.

Fri, 06/21/2013 - 09:33 | 3678885 involuntarilybirthed
involuntarilybirthed's picture

they want you to think they are too complicated

Fri, 06/21/2013 - 08:08 | 3678589 stinkhammer
stinkhammer's picture

Whichever way your pleasure tends if you plant ice you're gonna harvest wind.

Fri, 06/21/2013 - 08:08 | 3678591 ZeroPoint
ZeroPoint's picture

Are those the same risk models that gave AAA rating to worthless mortgage back securities?

Fri, 06/21/2013 - 08:08 | 3678592 Doubleguns
Doubleguns's picture

Noted  "it could translate into further selling on Friday or early next week."

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