If someone were to take a poll, I wonder what fraction of TLT shareholders in the general population would say they're aware of the fact that the fund lends out a large fraction of its U.S. Treasury bonds (near-zero credit risk) to private speculators (certainly non-zero credit risk). It might be an exaggeration for me to say that this is fraud dressed in a cheap tuxedo, but I don't think so.
I don't think the lending they do is in any way defensible, however I think it's perhaps not quite as bad as it may seem. My understanding is the collateral for such loans is typically cash equal to 100% of the value of the loan, marked to market every day. The exposure to the borrower's credit risk amounts to how much the price of the bonds might move in a single day.
This whole scheme leads to an interesting question - what does the ETF do with the borrower's cash? If they're loaning their shareholders' securities to make an extra buck or two, I find it hard to believe they'd let a fairly substantial pile of cash JUST SIT THERE! OMFG - it's just sitting there not making any money at all!!?? I think the real danger here is not the borrower's creditworthiness, but what they might do with the borrower's
cash. I haven't read the prospectus in a while. Maybe they spell all this out. And maybe in their annual statements they say exactly who the borrowers are and what the ETF actually does with the cash kept as collateral. I mean, it's not like they're greedy bastards who would sell out their own mother for a nickel - they're on the shareholder's side and they wouldn't be doing any of this if it didn't benefit the shareholder. They said so themselves, right? What could possibly go wrong?
Full disclosure: I used to hold my entire LT allocation in TLT but converted it to actual LT bonds 4 or 5 months ago in response to the initial thread here about funds/ETFs loaning securities. I'm converting my SHY holdings to a short term ladder of actual bonds as well. I think I'll sleep better when I'm done.