Chicago - Derivatives increase the risk that a financial crisis will spread at a faster pace throughout the markets, Alan Greenspan, the chairman of the Federal Reserve Board, said here yesterday.
While derivatives enhance the efficiency of the financial system, if a derivatives counterparty becomes insolvent or some other crisis occurs, "the efficiency of the system created by the complexity of financial management that has emerged is likely to mean that the crisis will move much more rapidly," Greenspan said in a speech to a group of bankers.
Greenspan is one of several regulatory officials who are beginning to acknowledge knot derivatives increase systemic risk, that is, the risk that an isolated crisis could snowball and spread to other markets.
Derivatives are nevertheless useful because they help companies manage and reduce their risk, Greenspan observed.
He cautioned the bankers to view derivatives broadly. "We must remember that derivatives are nothing more than an expansion of the overall structure of risk management for all types of credit and equity portfolios," Greenspan said.
Derivatives "are not a distinct and separable instrument by themselves," he said. "They are part of an evolving portfolio risk management system."
Any attempt to define derivatives as exotic new instruments or products, Greenspan said, "is really to miss the history of the evolution of risk management in the banking financial system."
He made the comments after being asked about the risks of derivatives.