Greenspan defends Fed's intervention in fund disaster
Copyright © 1998 Nando.net
Copyright © 1998 The Associated Press
WASHINGTON (October 1, 1998 10:56 a.m. EDT nandotimes.com) -- If Federal Reserve officials had not participated in a $3.6 billion private bailout of a major hedge fund, global disruption could have followed, Federal Reserve Chairman Alan Greenspan said Thursday.
He defended the central bank's involvement in the rescue, which partially protected wealthy investors in Long-Term Capital Management LP, who had bet big on interest-rate swings and lost.
"Financial market participants were already unsettled by recent global events," Greenspan said in testimony prepared for the House Banking Committee.
"Had the failure of LTCM triggered the seizing up of markets, substantial damage could have been inflicted on many market participants, including some not directly involved with the firm, and could have potentially impaired the economies of many nations, including our own," he said.
Greenspan, appearing with William J. McDonough, president of the New York Federal Reserve Bank, who helped arrange the Sept. 23 rescue of the hedge fund by a group of major banks and brokerage firms, acknowledged there was "moral hazard" in partially protecting the fund's owners.
But, Greenspan said, Fed officials were worried about the potential for a disruptive "fire sale," if the fund were liquidated, that would have risked a credit crunch for other borrowers -- what Greenspan called "a severe drying up of market liquidity."
"In situations like this, there is no reason for central bank involvement unless there is substantial probability that a fire sale would result in severe, widespread and prolonged disruptions to financial market activity," he said.
He said the Fed participated "solely to enhance the probability of an orderly private-sector adjustment," that no Federal Reserve funds were put at risk and that none of the firms in the rescue group were pressured to participate.
He said there was a long tradition of such rare interventions, dating back to the Panic of 1907, when J.P. Morgan convened a meeting of the world's most powerful bankers in his library.
However, the House Banking Committee chairman, Rep. Jim Leach, R-Iowa, said the Fed-led rescue raised "troubling questions of financial concentration and antitrust."
"The bailout may involve a tendency toward concentration that the Justice Department has an obligation to review," he said.
The rescue group includes Merrill Lynch & Co., Bankers Trust, Chase Manhattan, Morgan Stanley Dean Witter, J.P. Morgan, Goldman Sachs, Salomon Smith Barney and several big European banks. Its representatives declined Leach's invitation to testify.
"Working as a cartel, these institutions could influence economies for good or for naught, potentially in ways that may not be guided by any standard of national or international interest," Leach said.
Leach questioned how federally regulated commercial banks, whose deposits are insured by taxpayers, could extend such large credit lines to Long-Term Capital Management.
But Greenspan said a preliminary review suggested "the banks have collateral adequate to cover most of their current mark-to-market exposures" with the hedge fund.
Long-Term Capital Management is one of as many as 4,000 hedge funds controlling as much as $400 billion in investor equity. They are not subject to the same kind of strict disclosure and oversight rules as mutual funds because participants presumably have the resources to look after themselves.
Securities laws limit participation in each fund to 500 investors. Individuals must have incomes of at least $200,000 in each of the past two years ($300,000 for couples) or a net worth of at least $1 million.
Greenspan said they probably should not be more strictly regulated. Otherwise, they would move overseas and operate in cyberspace.
"The best we can do in my judgment is what we do today: Regulate them indirectly through the regulation of the sources of their funds. We are thus able to monitor far better hedge funds' activity," he said. "If the funds move abroad, our oversight will diminish."
By DAVE SKIDMORE, The Associated Press
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