Derivatives still safe, Fed says

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The Independent Online
US Federal Reserve Board chairman Alan Greenspan said it would be "a serious mistake" to single out derivative instruments for special regulatory treatment in the wake of the bankruptcy of Orange County, California.

In a testimony prepared for the Senate Banking Committee, Mr Greenspan said that new curbs on derivatives could lead to a "net loss" in market efficiency as market participants shift into less efficient instruments. New measures would "create artificial incentives to structure transactions on the basis of regulatory rules," rather than on simple economic terms,'' he said.

Mr Greenspan added that recent losses in the financial markets "have not led to broader systemic problems".

The Fed's recent enforcement agreement relating to Bankers Trust Corp. to improve supervision of the bank's sale of risky derivatives to corporate customers was specific to the bank and "should not be taken as a new general guideline for derivative dealings," he said.

Instead, "each institution needs to have effective procedures and controls tailored to that institution's own products and practices".

Orange County declared bankruptcy on 6 December as a result of losses suffered by its main fund. The fund, which used arrangements known as "repurchase" agreements to buy $20bn of securities with a down payment of just $7.5bn, has suffered $2bn in lossesfrom its investment in risky securities.

Mr Greenspan added that "it is by no means clear that these [Orange County] losses have been attributed solely or even primarily to financial instruments that would typically be called derivatives."

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