Testimony: Kauffman Foundation on ETFs Danger to Capital Formation


ETFs and the Present Danger to Capital Formation

Prepared Testimony by Harold Bradley and Robert E. Litan

Before the United States Senate Committee on Banking, Housing, and Urban Affairs Subcommittee on Securities, Insurance, and Investments

ETFs have increasingly distorted the role of equities
markets in capital formation, while posing systemic risks from potential
settlement failures.

The past 12 years reveal that fewer and fewer U.S. companies elect
to trade on primary U.S. stock markets. The number of exchange-traded stocks dropped almost 30 percent—from about 6,200 to 4,300 today. During that same time, the Securities and Exchange Commission (SEC) gave ETF sponsors a free pass from certain U.S. securities regulations. The predictable response? The number of ETFs grew exponentially—11 times—from 95 to more than 1,100 (Chart 1).

When financial assets move in highly correlated ways, regulators should worry
that capital markets are not doing their principal job—that is, properly allocating capital between different assets or financial instruments in such a way as to properly discipline risk-and-reward success.

PDF (31 Pages): Kauffman on ETFs Danger 2011