Time to Call a Halt to New Financial Products
By Jim Cramer
RealMoney Columnist
6/3/2010 4:20 PM EDT
How about a moratorium, a moratorium on financial innovation until we figure out what the heck the Bush people approved during the reckless years of the Securities and Exchange Commission? We are hearing once again about a whole new group of products, ETFs that mimic exotic hedge-fund strategies -- last week's nightmare revelation -- and I am sure it will go right into the queue of the SEC and be approved lickety-split because of some ill-found principles ginned up under the anything-goes Bush SEC.
Here's my suggestion. Just like we need to halt any new drilling in the Gulf until we figure out how to prevent the greatest ecological disaster, perhaps ever, we need to halt financial innovation until we figure out what the heck went wrong in the "flash crash" and the role of the ETFs and the other derivatives related to the super quickness of the new world. We keep hearing analogies to race cars that can go 160 mph that still have to obey a 65 mile an hour speed limit when driving in civilian traffic. All well and good, except that the people behind the machines don't believe there should be speed limits, and the exchanges themselves are so eager and greedy for market share that they cannot self-regulate. They will lose.
I think the better analogy is to World War I, where the technology of weaponry vastly overrode the ability of humans to deal with the newfound firepower. The financial markets, however, are not like wars. We need to protect soldiers, the regular investors, and we can do it. We aren't engaged in a titanic struggle between nations. We are trying to figure out how to get more regular players into the markets, not trying to figure out how to kill as many soldiers as possible with our fabulous new machine guns.
The financial innovation is like battlefield innovation, though. The innovators claim that they are providing liquidity, but they have turned the playing field into a battlefield, so the players are, justifiably, leaving.
It is worse. The SEC is busy trying to protect major and sophisticated financial institutions, such as the German bank that Goldman Sachs (GS - commentary - Trade Now) allegedly hurt, instead of trying to protect individuals from rapacious products like the Ultra ETFs. Think about it this way. We know that the Goldman product in dispute, which was meant to mimic the housing market, did exactly that. But the public believes that the Ultra products, particularly the short products, are meant to hedge or protect from down markets. All they really do is track volatility on a daily basis. They don't do what people believe they are designed to do. So we have this ridiculous situation where the SEC is protecting sophisticated investors from something that worked -- even though it went down -- and allowing mom-and-pop investors to be decimated by products that don't work the way that they believe they do.
Now, we add the new wrinkle of the flash crash, which shows that not only do these products not do what the public thinks they do -- driving the public further from the market - they actually affect the underlying stocks, because the markets are so thin, often in vicious ways, including the flash-crash action. The algorithmic programs of the high-frequency traders detect the big orders from some of the products that have been created under the Bush years and back away from the market. That's the mile-wide fraction of an inch-deep sucking of liquidity out of the market.
We need to halt these innovations until we re-evaluate their consequences on the markets and on the public. Just like the oil platform inspections were done in boom times for the oil group, the analysis of these products, particularly the Ultras, was completed during the greatest bull market in history, when there were many players and much volume. Even the faulty studies done by the SEC to justify approving these products said that they could influence the close if the markets weren't so deep, but we know from the flash crash that they aren't deep enough at all and certainly can't handle the volumes these innovations generate, particularly at the close.
Why not pause? Why not figure out the "worth" of these products for individuals, as the Senate debated the worth of the Goldman contraption that was Abacus?
The last time I heard such praise for financial innovation was the move by a handful of institutions to offer portfolio insurance that would protect these funds in a downside. What did it do? It both caused the downside and didn't work the way it was supposed to. That's what the innovations are doing again. Portfolio insurance went away.
These instruments should too. And I bet any study of their impact and uses now would show exactly that. No more innovation. Just analysis. A halt in the creation of new products until we figure out impact and harm. We say yes to it in the Gulf of Mexico. Let's say yes to it on Wall Street.
At the time of publication, Cramer was long GS. |
