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Fed wary of derivative rules
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March 19, 1999: 10:53 a.m. ET
Greenspan calls imposing new rules on banks' use of contracts a 'mistake'
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NEW YORK (CNNfn) - Despite worries about derivatives, regulators should not impose heavier burdens on banks using the complex contracts to manage risk, Federal Reserve Chairman Alan Greenspan said Friday.
Indeed, the central bank chairman said that derivatives -- contracts that derive their value from an underlying stock, commodity or financial instrument -- have helped create wealth and improve standards of living by better allowing companies and financial markets to spread and manage risk.
In a speech delivered to the Futures Industry Association in Boca Raton, Fla., Greenspan did say banks should be "stress testing" models used to assess possible losses from derivatives in financial panics.
He said about $33 trillion worth of derivatives were outstanding at the end of 1998 and that there was no sign the Asian crisis that began in 1997 was slowing their growth. Only $4 trillion are traded on exchanges, with the rest traded in over-the-counter (OTC) or off-exchange deals.
"As I have noted previously, the fact that the OTC markets function quite effectively without the benefits of the Commodity Exchange Act provide a strong argument for development of a less burdensome regime for exchange-traded financial derivatives," he said.
Greenspan said it would be "a major mistake" to increase rules on how banks assess risks when they use derivatives. But he urged "stress testing" by banks of the models they use to weigh their own risks since financial panics could spell big losses.
He said big losses reported by firms that invested heavily in derivatives last summer -- when global financial markets sank after Russia defaulted on billions of dollars in debt -- reflected big declines in prices of stocks, commodities and bonds issued by developing countries.
"Derivative instruments were bystanders," Greenspan said. "They may well have intensified the losses in underlying markets, but they were scarcely the major players."
Using derivatives to manage risks can be risky itself if everybody rushes to sell at once. But it has allowed investors and businesses to better use their capital to produce more of what consumers want, Greenspan said, "a process that has undoubtedly improved national productivity growth and standards of living."
The Fed chairman delivered his speech via satellite link from Washington. A text of the speech was issued by the central bank.
-- from staff and wire reports 
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Greenspan's speech
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