the warning
COMMENTS comments

In His Own Words

Some of Greenspan's statements over the years on over-the-counter derivatives and market regulation

From his Feb. 10, 2000 testimony (PDF) before the Senate Committee on Agriculture, Nutrition and Forestry

"Exceptionally important ... instruments" whose users "do not require ... protections"

Over-the-counter (OTC) derivatives have come to play an exceptionally important role in our financial system and in our economy. These instruments allow users to unbundle risks and allocate them to the investors most willing and able to assume them. A growing number of financial and non-financial institutions have embraced derivatives as an integral part of their risk capital allocation and profit maximization. ...

In light of the importance of OTC derivatives, it is essential that we address the legal uncertainties created by the possibility that courts could construe OTC derivatives to be futures contracts subject to [regulation under] the CEA [Commodities Exchange Act]. The legal uncertainties create risks to counterparties in OTC contracts and, indeed, to our financial system that simply are unacceptable. ... Rapid changes in communications technology portend that time is running out for us to modernize our regulation of financial markets before we lose them and the associated profits and employment opportunities to foreign jurisdictions that impose no such impediments. ...

OTC transactions in financial derivatives are not susceptible to -- that is, easily influenced by -- manipulation. The vast majority of contracts are settled in cash, based on a rate or price determined in a separate highly liquid market with a very large or virtually unlimited deliverable supply. ... With respect to fraud and other unfair practices, the professional counterparties that use OTC derivatives simply do not require the protections that CEA provides for retail investors. If professional counterparties are victimized, they can obtain redress under the laws applicable to contracts generally.

From his July 16, 2003 testimony before the Senate Committee on Banking, Housing and Urban Affairs

"Extraordinarily useful ... transactions amongst professionals"

What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who should not be taking it to those who are willing to take it and are capable of doing so. Prior to the advent of derivatives on a large scale we did not have that capability, and we often had, for example, financial institutions like banks taking on undue risk and running into real serious problems. ...

[In] the United States, [derivatives] are obviously regulated to the extent that banks, being the crucial creators of these derivatives, are regulated by the banking agencies, but not beyond that. The reason why we think it would be a mistake to go beyond that degree of regulation is that these derivative transactions are transactions amongst professionals, and the institutions which are involved have very considerable what we call counterparty surveillance, where, for example, one major bank will know far more about its customer, whether it is a bank or something else, than we could conceivably know as regulators. In a sense this counterparty surveillance has become the crucial element which has created stability in that particular system.

From his memoir, The Age of Turbulence: Adventures in a New World, published in September 2007

"Too complex" for "twentieth-century supervision and regulations"

Markets have become too huge, complex and fast moving to be subject to twentieth-century supervision and regulations. ... Regulators can still pretend to provide oversight, but their capabilities are much diminished and declining. ... Regulation, by its nature, inhibits freedom of market action, and that freedom to act expeditiously is what rebalances markets. Undermine this freedom and the whole market-balancing process is put at risk. We never, of course, know all the many millions of transactions that occur every day. Neither does a U.S. Air Force B-2 pilot know, or need to know, the millions of automatic split-second computer based adjustments that keep his aircraft in the air.  

From his memoir, The Age of Turbulence: Adventures in a New World, published in September 2007

"A boon to banks" with "buffering power"

The CDS [credit default swap], as it is called, is a derivative that transfers credit risk, usually of a debt instrument to a third party, at a price.  Being able to profit from the loan transaction but transfer credit risk is a boon to banks and other financial intermediaries. ... A market vehicle for transferring risk away from these highly leveraged loan originators can be critical for economic stability, especially in a global environment. In response to this need, the CDS was invented and took the market by storm. ... The buffering power of these instruments was vividly demonstrated between 1998 and 2001, when CDSs were used to spread the risk of $1 trillion in loans to rapidly expanding telecommunications networks. ... The losses were ultimately borne by highly capitalized institutions. ... They were able to absorb the hit. ... It is a process that continually improves the efficiency of directing scarce savings to their most productive investment. 

From an epilogue added to the August 2008 edition of Greenspan's memoir, The Age of Turbulence: Adventures in a New World

"Flexibility ... unencumbered by protectionism"

The best strategy is to ensure that our markets at all times have enough flexibility and resilience, unencumbered by protectionism or rigid regulation, to absorb and mitigate the shock of the crisis.

From his Oct. 2, 2008 speech (PDF) at the Georgetown University Sandra Day O'Connor Project Conference

Laws versus trust

In a market system based on trust, reputation has a significant economic value. I am therefore distressed at how far we have let concerns for reputation slip in recent years. Reputation and the trust it fosters have always appeared to me to be the core attributes required of competitive markets. Laws at best can prescribe only a small fraction of the day-by-day activities in the marketplace. When trust is lost, a nation's ability to transact business is palpably undermined.

From his Oct. 23, 2008 testimony (PDF) before the House Committee on Oversight and Government Reform

"A flaw in the model"

Rep. Henry Waxman (D-Calif.): The question I had for you is you had an ideology. You had a belief that free, competitive -- and this is shown -- your statement, "I do have an ideology. My judgment is that free, competitive markets are by far the unrivaled way to organize economies. We have tried regulation, none meaningfully worked." ... [Do] you feel that your ideology pushed you to make decisions that you wish you had not made?

Greenspan: Well, remember [what an ideology is]. ... It's a conceptual framework with the way people deal with reality. Everyone has one. You have to. To exist, you need an ideology. The question is whether it ... is accurate or not. And what I'm saying to you is yes, I found a flaw. I don't know how significant or permanent it is. But I have been very distressed by that fact. ... I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.

posted october 20, 2009

the warning home page · watch online · dvd/transcript · credits · site map
FRONTLINE series home · privacy policy · journalistic guidelines

FRONTLINE is a registered trademark of WGBH Educational Foundation.
Web Site Copyright ©1995-2014 WGBH Educational Foundation