Greenspan Warns About Concentration in Derivatives (Update1)                    
                                                                                
     
                                                                                
     Washington, May 8 (Bloomberg) -- Fewer firms are making                    
markets in certain over-the-counter derivative contracts, raising               
the risk that a single company's exit may cause substantial                     
disruptions, Federal Reserve Chairman Alan Greenspan said.                      
     ``One development that gives me and others some pause is the               
decline in the number of major derivatives dealers and its                      
potential implications for market liquidity and for concentration               
of counterparty credit risks,'' Greenspan told a banking                        
conference sponsored by the Chicago Fed.                                        
     The Fed chairman didn't comment on interest rates or the                   
state of the economy in his speech, which he delivered by                       
satellite. Earlier this week, the Federal Open Market Committee                 
left its key rate at 1.25 percent, and said growth in the U.S. is               
at risk of weakening further.                                                   
     Greenspan said that in the markets for U.S.-dollar interest-               
rate options and credit-default swaps, ``a single dealer seems to               
account for about one-third of the global market and handful of                 
dealers together seem to account for more than two thirds.''                    
     Market makers are traders who stand ready to buy when                      
investors want to sell and vice versa. The ease of trade they                   
provide is known as liquidity.                                                  
     J.P. Morgan Chase & Co., the second-biggest U.S. bank, is the              
world's largest user of derivatives -- contracts based on things                
varying from gold to weather, with most linked to interest rates,               
stocks, and bonds. Derivatives traded outside exchanges grew 11                 
percent to a record $142 trillion in the second half of last year,              
led by contracts pegged to euro-region interest rates, the Bank                 
for International Settlements said.                                             
     Interest-rate swaps are agreements to exchange fixed interest              
rates for floating rates, or vice versa. Credit-default swaps are               
used to insure against missed debt payments. The buyer pays the                 
seller a premium in exchange for the full value of a company's                  
bonds in the event of a default.                                                
                                                                                
                        `Chain of Defaults'                                     
                                                                                
     Greenspan said market participants have to be aware that the               
ability to buy and sell contracts may be limited if one large                   
dealer leaves the market. Such a concentration also increases the               
amount of credit risk in the market, he said.                                   
     ``Concentration of market-making has the potential to create               
concentrations of credit risks between the dealers and the end                  
users of derivatives,'' the Fed chairman said. ``Critics of                     
derivatives often raise the specter of the failure of one dealer                
imposing debilitating losses on its counterparties, including                   
                                                                                
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                     Copyright (c) 2003, Bloomberg, L. P.                      

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other dealers, yielding a chain of defaults.''                                  
     Greenspan also warned that market participants must do more                
to improve disclosure and understanding of risks in derivatives.                
     ``Transparency challenges market participants not only to                  
provide information but also to place that information in a                     
context that makes it meaningful,'' he said. ``Much disclosure                  
currently falls short of these more demanding goals.''                          
                                                                                
                       `Enhanced Resilience'                                    
                                                                                
     At the same, Greenspan said derivatives contracts, such as                 
credit-default swaps, have helped banks manage their risks in                   
volatile economic times. Even with large bankruptcies such as                   
those of WorldCom Inc. and Enron Corp., and record sovereign                    
defaults, such as Argentina, bank capital hasn't been                           
significantly damaged, he said.                                                 
     Greenspan repeated his contention that ``market discipline''               
is a more effective regulator of the derivatives industry than the              
federal government would be.                                                    
     ``The use of a growing array of derivatives and the related                
application of more sophisticated methods for measuring and                     
managing risk are key factors underpinning the enhanced resilience              
of our largest financial intermediaries,'' the Fed chairman said.               
``The benefits of derivatives, in my judgment, have far exceeded                
their costs.''                                                                  
                                                                                
--Craig Torres in Washington (202) 654-1220 or at                               
ctorres3@bloomberg.net, with Joe Maguire and Tom Kohn in London.                
Editor: McKee