Yet in calm language and detached tone, Greenspan has been saying that he does not intend to exercise his responsibility as Fed Board Chairman to regulate OTC financial derivatives, even though he recognizes such instruments as being certain to produce unpredictable but highly damaging systemic risks. They justification for no-regulation is: if we don't smoke, someone else will off shore and that it is a price we must accept for a growth economy. It sounds like that we each individually have to take measure to protect ourselves: either miss out on the boom, or risk being wiped out by the bust. It is unpatriotic not to participate. With the rise of monetarism, the Fed, together with the Treasury Department, have evolved from traditionally quiet functions of insuring the long term value and credibility of the nations currency, to activist promotions of economy boom, replacing the Keynesian economic role of the Federal Budget. Never before has any central banker advocated and celebrated the institutionalization and socialization of risk as an economic policy. As Anthony Giddens, director of the London School of Economics, explains in his The Third Way: "nothing is more dissolving of tradition than the 'permanent revolution' of market forces."
Henry C.K. Liu
Excerpts from Remarks by Chairman Alan Greenspan on Financial derivatives Before the Futures Industry Association, Boca Raton, Florida March 19, 1999
By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives. At year-end, U.S. commercial banks, the leading players in global derivatives markets, reported outstanding derivatives contracts with a notional value of $33 trillion, a measure that has been growing at a compound annual rate of around 20 percent since 1990.
Of the $33 trillion outstanding at year-end, only $4 trillion were exchange-traded derivatives; the remainder were off-exchange or over-the-counter (OTC) derivatives.
.... the fact that the OTC markets function quite effectively without the benefits of the Commodity Exchange Act provides a strong argument for development of a less burdensome regime for exchange-traded financial derivatives.
On a loan equivalent basis, a reasonably good measure of such credit exposures, U.S. banks' counterparty exposures on such contracts are estimated to have totaled about $325 billion last December. This amounted to less than 6 percent of banks' total assets. Still, these credit exposures have been growing rapidly, more or less in line with the growth of the notional amounts.
.... a Bank of International Settlements survey for last June .... estimated that size of the global OTC market at an aggregate notional value of $70 trillion, a figure that doubtless is closer to $80 trillion today. Once allowance is made for the double-counting of transactions between dealers, U.S. commercial banks' share of this global market was about 25 percent, and U.S. investment banks accounted for another 15 percent. While U.S. firms' 40 percent share exceeded that of dealers from any other country, the OTC markets are truly global markets, with significant market shares held by dealers in Canada, France, Germany, Japan, Switzerland, and the United Kingdom. Despite the world financial trauma of the past eighteen months, there is as yet no evidence of an overall slowdown in the pre-crisis derivative growth rates, either on or off exchanges. Indeed, the notional value of derivatives contracts outstanding at U.S. commercial banks grew more than 30 percent last year, the most rapid annual growth since 1994.
...... during panic periods the usual assumption that potential future exposures are uncorrelated with default probabilities becomes invalid. For example, the collapse of emerging market currencies can greatly increase the probability of defaults by residents of those countries at the same time that exposures on swaps in which those residents are obligated to pay foreign currency are increasing dramatically.
Whole speech: http://www.bog.frb.fed.us/BoardDocs/Speeches/Current/19990319.htm
Greg Nowell wrote:
> It's very common for international investors & traders to arbitrage such
> discrepancies.
The fact is most of the trades are done by commercial banks, not trader and investors. The question of moral hazard is real because no one believes that the Fed will let Chase or Citibank go under.
Henry C.K. Liu