UltraShort ETF Losses Go to 'Money Heaven'

The development of these funds has been a boon to daytraders. If I focused in on it, I am positive I could make a bundle trading the SKF. The reason is that their very construct leads to a self-fulfilling prophecy. A normal security has two sources of buyers (an initiating long or exiting short) and two sources of sellers (exiting long or initiating short). By bifurcating the market and segmenting longs from shorts, the construct of these funds has eliminated half of the liquidity -- no one would go long the market by shorting the short fund. Therefore, the market maker in a trending market is forced to hedge.

So I know if I buy a short ETF, I can force the action by putting pressure on the underlying stocks. This leads to cascading selling pressure -- not just from the leverage imbedded, but also from the follow-on action.

I have no doubt that the existence of these funds exacerbated the selling pressure in the market -- we have quantified this previously. In turn, these have cost the taxpayer even more money.

Speaking of foisting greater cost on the taxpayer -- ProShares (the largest purveyor of these levered and short ETFs) recently took out a full page ad in Barron's: "Now, ETFs for when Treasuries fall." Thanks. Not only did your products likely increase the cost of the bailout, but now you are seeking to help increase the cost of financing the bailout. I know, I know -- you are only offering what people want to buy, but in our sound-byte society, are you not reflecting at all on your actions? (Please see my previous piece on why I think shorting Treasuries is not a great idea right now.)

If you read the message boards on some of these products, you can sense the anger that the posters have towards the financial mess, and they are taking it out by buying the SKF or the SRS. But I doubt they are thinking that they may actually be contributing to the greater problem and the greater cost to the taxpayer.

The greatest irony here is that with all this wealth destruction, the holders of the SKF and SRS are also sending money to money heaven in bundles. It seems that the only winners in this whole thing are the fund companies that provide these, the market manipulators and a handful of daytraders.

Testifying before Senate committee 10 days ago, SEC Chairman Mary Schapiro stated: "Even as attention focuses on reconsidering the management of systemic risk, investor protection and capital formation -- both of which are fundamental to economic growth -- cannot be compromised as a product of any reform effort."

If protecting investors and capital formation are truly a primary focus of this SEC, the agency will need to revisit the approval of these instruments in the context of reinstating the uptick rule.