WASHINGTON - Federal Reserve chairman Alan Greenspan rejected Thursday US government regulation of hedge funds, while acknowledging that high-risk investment strategies can destabilise the financial system.
In a speech delivered via satellite to a banking conference in Chicago, the US central banker said the growth of sophisticated derivative products was generally welcome as they made the banking system more resilient to shocks.
But the concentration of only a few players in some derivatives markets, such as for US dollar interest rate options, was grounds for concern as the failure of one could convulse the whole sector, he said.
"Yet the history of the development of these products encourages confidence that many of the newer products will be successfully embraced by the markets," Greenspan said according to the text of the speech made available here.
"To be sure, for that favorable record to be extended, both market participants and policymakers must be aware of the risk-management challenges associated with the use of derivatives to transfer risk, both within the banking system and outside the banking system," he said.
"And they must take steps to ensure that those challenges are addressed."
The Fed chairman touched on the 1998 failure of Long Term Capital Management (LTCM) as an example of the risks associated with a hedge fund holding too large a position in an illiquid market.
LTCM's collapse seemed at one point to threaten the entire global financial system, before the Fed stepped in to guarantee liquidity to Wall Street.
In the wake of the LTCM shock, US markets have been roiled by several scandals at mutual funds, which control a large chunk of the investments of US consumers.
Nevertheless, Greenspan said, markets are generally more efficient at controlling risk than the government, including for hedge funds.
"We regulators are often perceived as constraining excessive risk-taking more effectively than is demonstrably possible in practice," he said.
"Except where market discipline is undermined by moral hazard, for example, because of federal guarantees of private debt, private regulation generally has proved far better at constraining excessive risk-taking than has government regulation," Greenspan added.
05/05/2005 14:36 GMT