WASHINGTON -- The head of the Public Securities AssociatiOn cautioned yesterday that public reaction to derivatives may have gone too far and that avoiding the use of the financial products can also be a risk to issuers and investors.

"It seems to me that, in the current environment, there is a risk that the pendulum is swinging too far toward a kind of false fiscal conservatism," PSA president Heather Ruth said in a speech at a public pension seminar held in Texas.

Ruth said municipalities should not overreact to recent reports of losses and increased attention given to derivatives in the media.

She said the innovations in structured securities and other instruments allow issuers and investors to assess their entire financial picture and make informed financial decisions.

"I would be very surprised if less than half of all public retirement systems had invested at some time in structured securities like GNMA mortgage pass-throughs or PAC-type CMOs issued by federal agencies," she said.

"The economic costs of lost opportunities are real for taxpayers, though less overt and sensational than the kind of portfolio blunders that have made the evening news," Ruth said. "I see risk as including the risk that a municipality will pay 10 basis points more than it needed to on a bond because of fear and loathing of the 'D' word,"

Meanwhile, Ruth emphasized the need to focus on market risks in addition to credit risks when making derivatives investments. Products with little credit risk can still be risky investment tools.

"It is crucial that we don't focus too narrowly on credit risk," Ruth said. "Market risk may be a greater threat; it is present for all investments, even those nearly 'risk free' instruments that bear the full faith and credit of the United States."

Ruth warned that public investors need to make sure they are authorized to make certain investments. "This is fundamentally your responsibility -- not the responsibility of people who come to you with investment ideas," she said.

In addition, she stressed the importance that pension fund managers understand the investment decisions they are making.

"Make sure you understand exactly what you are doing," Ruth said. "If that is impractical, hire someone to do it in your behalf."

She said derivatives should be used as a hedge and not to speculate. "Use them principally to save money or to protect yourselves against downside scenarios."

With respect to policymakers, Ruth said it is important to be precise when defining derivatives. She said a bill drafted by the House Banking Committee defined derivatives too broadly.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.