ETFs caused May 06 Flash Crash?O
Saw this interesting article. I don't personally know all that much about ETFs, but I was wondering what you guys thought.
From the Financial Times:
Kauffman: ETFs are the problem, not HFT
Posted by Izabella Kaminska on Nov 08 21:00.
Finally, a report that dares to outline the previously-taboo: Exchange-Traded Funds may pose a greater systemic threat to markets than high-frequency, or algorithmic, trading.
Writing for the Kauffman Foundation, a Kansas City-based private and nonpartisan foundation, authors Harold Bradley and Robert E. Litan lay the case out in a 86-page report on Monday. Both these guys have testified to the US Congress on things like market structure and financial crises, so they’re well worth listening to.
At issue, they say, is the price discovery process itself:
We show here that ETFs are radically changing the markets, to the point where they, and not the trading of the underlying securities, are effectively setting the prices of stocks of smaller capitalization companies, or the potential new growth companies of the future. In the process, ETFs that once were an important low-cost way for investors to assemble diversified stock holdings are now undermining the traditional price discovery role of exchanges and, in turn, discouraging new companies from wanting to be listed on US exchanges.
That is not all. The proliferation of ETFs also poses unquantifiable but very real systemic risks of the kind that were manifested very briefly during the ‘Flash Crash’ of May 6, 2010. Absent the ETF-related reforms we outline below in this summary, and in more detail in the text, we believe that other flash crashes of small capitalization company “melt ups,” potentially much mroe severe than the one on May 6, are a virtual certainty.