<font color=red>Greenspan Sees Risks in Derivatives</font>
Thursday May 8, 2:06 pm ET
By Victoria Thieberger
biz.yahoo.com
CHICAGO (Reuters) - Federal Reserve Chairman Alan Greenspan on Thursday expressed concern over the risks posed to financial markets by the concentration of the $142 trillion derivatives market in the hands of a few investment banks.
Greenspan repeated his usual praise for derivatives, saying their benefits had materially outweighed the risks and had insulated the financial system from the stock market crash and economic downturn.
But, for the first time, he detailed the potential dangers to financial markets if one of the major derivatives dealers had to exit the derivatives market, and called for more meaningful disclosure of derivatives use.
'I do not wish to suggest ... that I am entirely sanguine with respect to the risks associated with derivatives,' Greenspan told a conference organized by the Chicago Fed.
Greenspan repeated his opposition to regulating derivatives, but said heavy concentration in the market 'gives me and others some pause.'
'If a major dealer exited and other dealers were unwilling to fill the void, the liquidity of the market likely would be impaired,' Greenspan said.
Derivatives are contracts based on underlying securities or other variables, ranging from interest rates and currencies to energy and weather. They allow investors both to spread risk and to make big leveraged bets.
According to the Swiss-based Bank for International Settlements (News - Websites), the global over-the-counter derivatives market had grown to nearly $142 trillion by the end of last year.
In his speech, delivered to the conference by satellite, Greenspan said that a single dealer accounts for about a third of the global market in both interest rate and credit derivatives, and a few dealers account for more than two-thirds.
Representatives of J.P. Morgan Chase, the biggest player in both those markets, were not immediately available to comment.
'When concentration reaches these kinds of levels, market participants need to consider the implications of exit by one or more leading dealers,' Greenspan said.
'Such an event could adversely affect the liquidity of types of derivatives that market participants rely on for managing risks of their core business functions.'
In March, investor Warren Buffett (News) called derivatives financial 'weapons of mass destruction' and last week renewed a call to be aware of the dangers of derivatives, saying U.S. financial institutions 'don't want to think about it before it happens.'
But Greenspan told the Chicago conference he believes derivatives have helped make the U.S. banking and financial systems more resilient and noted 'continued vitality of most U.S. banks' despite the recent blows to the economy.
'Although the benefits and costs of derivatives remain the subject of spirited debate, the performance of the economy and the financial system in recent years suggests that these benefits have materially exceeded the costs,' Greenspan said.
A senior Wall Street swaps trader saw the speech as taking aim at the derivatives market. 'Greenspan's been good to us. He's never really had a problem with derivatives, until this speech,' he said.
The trader said he expected the market to become less concentrated and business to spread out among other investment banks as derivatives become more widely traded and profit margins decline.
Responding to questions on the broader economic outlook, Greenspan said he thought businesses have an abundance of investment projects in mind but lack confidence to proceed in the wake of recent corporate scandals.
'There is an awful lot of stuff sitting on corporate shelves which have been delayed and they are ready to go if and when the judgments are made to move,' he said. 'I think a goodly part of the caution is indeed the aftermath of this whole corporate governance issue.'
In a key difference from the early 1990s, Greenspan said he saw no risk of a credit crunch -- caused by banks' reluctance to lend -- holding back a stronger recovery.
'This time, the economic downturn has not significantly eroded the capital of most financial institutions, and the terms and availability of credit have not tightened to such an extent as to be significant factors in deepening the contraction or impeding the recovery,' the Fed chief said. (additional reporting by Glenn Somerville in Washington) |
