Thursday, October 09, 2008
please sir, can i have another $37.8 billion?
just when will america recognize that this is the collapse of the deregulated, free market model?
the right wing pundits and conservative republicans - knocking government until it's time to bail out their flagship institutions with taxpayers' money.
can't have it both ways.
Remarks by Chairman Alan Greenspan
At the 2003 Conference on Bank Structure and Competition, Chicago, Illinois
May 8, 2003
Benefits of Derivatives
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 those benefits have materially exceeded the costs.
Over the past several years, the U.S. economy has proven remarkably resilient in the face of a series of severe shocks--the collapse of equity values, terrorist attacks, and geopolitical turmoil. To be sure, economic growth has been subpar for some time, but we seem to have experienced a significantly milder downturn than the long history of business cycles and the severity of the shocks to the economy would have led us to expect. Although no single factor can account for this resilience, one striking feature that differentiates this cycle from earlier ones is the continued vitality of most U.S. banks and nonbank financial institutions.
In past cycles, economic downturns often produced credit losses that were so severe that the capacity of those institutions to intermediate financial flows was impaired. As a consequence, recessions were prolonged and deepened. This time, the economic downturn has not significantly eroded the capital of most financial intermediaries, 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 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. Derivatives have permitted financial risks to be unbundled in ways that have facilitated both their measurement and their management.
Because risks can be unbundled, individual financial instruments now can be analyzed in terms of their common underlying risk factors, and risks can be managed on a portfolio basis. Concentrations of risk are more readily identified, and when such concentrations exceed the risk appetites of intermediaries, derivatives can be employed to transfer the underlying risks to other entities. As a result, not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.
Individual institutions’ portfolios have become better diversified. Furthermore, risk is more widely dispersed, both within the banking system and among other types of intermediaries and institutional investors. Even the largest corporate defaults in history (WorldCom and Enron) and the largest sovereign default in history (Argentina) have not significantly impaired the capital of any major financial intermediary. Likewise, record amounts of home mortgage refinancing and accompanying declines in mortgage asset durations have not imperiled the principal intermediaries in the mortgage markets, in substantial part because these institutions were able to use derivatives to transfer a significant portion of the convexity risk associated with prepayments of fixed-rate mortgages to investors in callable debt and issuers of putable debt.
Risks Associated with the Use of Derivatives
If derivatives and the techniques for risk measurement and management that they have facilitated have produced all these benefits, why do they remain so controversial? The answer is that the use of these instruments and the associated techniques pose a variety of challenges to risk managers. Inevitably, risk-management failures occur, and in two instances--the highly publicized cases of Barings and Long Term Capital Management--they proved destabilizing.
Those that question the net benefits of derivatives see daunting risk-management problems and thus foresee catastrophic outcomes. In particular, they fear that common deficiencies in risk management will result in widespread failures or that the failure of a very large derivatives participant will impose heavy credit losses on its counterparties and yield a chain of failures. Others, like myself, who see the benefits of derivatives exceeding the costs, do not deny that their use poses significant risk-management challenges. But we see ample evidence that the risks are manageable in principle and generally have been managed quite effectively in practice, at least to date. Indeed, credit losses on derivatives have occurred at a rate that is a small fraction, for example, of the loss rate on commercial and industrial loans.
Market discipline in the largely unregulated derivatives markets has provided strong incentives for effective risk management and has the potential to be even more effective in the future.
To be sure, there undoubtedly will be further risk-management failures. But the largest market participants have such diversified businesses that a risk-management failure involving a single product line is unlikely to be a threat to solvency. Furthermore, risk-management failures are more likely to be idiosyncratic than to reflect common deficiencies in procedure or technique among market participants. In the case of the management of market risk, our bank examiners observe significant differences in approach across the largest U.S. banks, even in the measurement of such a basic concept as value-at-risk.
On March 17, 2008 Alan Greenspan wrote an article for the Financial Times' Economists’ Forum entitled “We will never have a perfect model of risk“, in which he argued: “We will never be able to anticipate all discontinuities in financial markets.” He concluded: “It is important, indeed crucial, that any reforms in, and adjustments to, the structure of markets and regulation not inhibit our most reliable and effective safeguards against cumulative economic failure: market flexibility and open competition.
... i would have to disagree.