The problems the ETF industry is having right now will eventually make the industry better.

Your last blog touched on some of those problems, Jim: the failure of the Lehman ETNs; the problems with the short funds; the difficulties in Europe with ETCs; the significant widening of spreads; the rise in tracking error.

There are more, including some we probably don't even know out about yet. But I have to think all these growing pains will eventually make things better. In fact, they already are.

Take the situation in Europe. After narrowly dodging an enormous bullet, ETF Securities has come up with a much better structure for its exchange-traded commodities. In the past, the ETCs were backed by the credit of AIG ... and nothing else. Yesterday, they announced that the funds would be fully collateralized going forward. That makes them better funds.

ETNs are an even better example. ETNs are a fine structure for some types of investments. There are areas of the market where ETFs simply can't go: MLPs, certain currencies, etc. There are also areas where tracking error is such a major problem that you could make a real argument for ETNs during a normal market cycle.

But ETNS have no place in plain equity strategies, or in mainline currency markets, or in many other traditional markets. Regular ETFs and mutual funds can do the job just fine.

In 2007 and the first half of 2008, we saw ETNs launching into areas where they don't belong. One of the reasons was that it was easier and faster for fund companies to launch ETNs than ETFs. That meant an ETN could gain "first mover" advantage in new markets, squeezing out ETFs despite the fact that ETFs would have worked perfectly well.

Those days are over. Investors have woken up to the reality of credit risk in the ETN market, and there's no way an ETN can compete with an ETF for assets in the same market right now. That means we'll get better and more appropriate product structures in those new markets. Ultimately, that's good for investors.

Sign Of The Apocalypse

I can't post a blog right now without at least mentioning recent market movements. Woo boy. The Dow is down 20.9% over the past seven days, and futures are trading lower this morning. Stock exchanges are halted in Russia, Vienna, Indonesia and other markets. Iceland appears to be bankrupt. Brazil's stock market is down 65% in five months.

My latest "sign of the apocalypse" came from a Reuters story, "U.S. Eyes Bank Equity Stakes as World Looks to G7," which stood at the top of the Yahoo Finance home page yesterday. The teaser read like this: "The United States moved closer to taking equity stakes in banks on Thursday ahead of a G7 meeting of economic powers trying to stave off world financial ruin." [Emphasis mine.]

"World financial ruin." Now that's a phrase you don't see very often in the mainstream media.

What I'm Watching

Like most of you, I'm looking at the market right now thinking, at some point, this gets too cheap to ignore. I know, I know: I'm a dyed-in-the-wool indexer. But these are wild times, and I have a little extra cash on the sidelines waiting to get back into the market.

When will I buy?

I'm looking at one thing and one thing only: the TED spread. The TED spread is the difference between interest rates on three-month Treasuries and the London Inter Bank Offered Rate (LIBOR), which is the rate banks use to lend to one another. It basically tells you the level of fear among banks.

Right now, governments are doing so much to try to unfreeze the credit markets that you can't possibly keep track of it all. The TED spread is the best way to see if the governments' efforts are working.

Historically, the TED spread has hovered between 0.1% and 0.5%. On October 9, it hit 4.14%, a new record. Bloomberg has a nice chart of it here.

Until that chart rolls, I ain't buying.