Within the medieval pseudoscience of alchemy there was a centuries-long search for a tool, the philosopher’s stone, that could turn worthless lead into ever-desirable gold. There has been a similar quest in the ETF world for the past few months: Could an ETF of toxic bank assets help the current financial crisis by converting impossible-to-sell securities into a transparent, market-priced portfolio? After all, ETFs have already brought exceptional liquidity for individual investors to previously obscure areas of the bond, commodity, and global equity markets. If liquidity really presents the main difficulty in valuing the toxic assets weighing down on bank balance sheets, could the millions of investors on major equity exchanges help? Here at Morningstar, we do not believe so for a multitude of reasons, involving both the nitty-gritty of how to build an ETF of toxic assets and the very nature of the complex securities that caused all this trouble in the first place.

Unfortunately, we have to defer the latter points to another article that delves into the rise and fall of structured finance, and how it led to such a large amount of precarious assets that now endanger the banks who created them. For now, we will just take as given that banks hold these complex assets, which are essentially deeds entitling the banks to a share of the payments on a variety of mortgage, business, and consumer loans. However, those shares of the payments have been sliced and diced multiple times, pass through several intermediaries, and have such a confused paper trail that no one in the banking world quite knows how much they’re worth anymore. If the prospects for these assets already sound pretty hopeless, you’re getting a pretty good idea of why we are so skeptical.

Full Story:  http://news.morningstar.com/articlenet/article.aspx?id=287803

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