WASHINGTON -- Despite concerns among lawmakers about the risks derivative investments pose, top federal regulators maintained yesterday that comprehensive legislation to regulate derivatives is not needed.
In a letter released yesterday, Federal Reserve chairman Alan Greenspan told a top lawmaker that the use of structured notes by bank-affiliated mutual funds poses little risk to the banking system and that current regulation is adequate.
At the same time, a group of federal regulators announced that adequate safeguards for the use of derivatives are already in place and major legislation should not be considered unless significant problems develop.
Greenspan's comments came in an Oct. 17 letter to Rep. Henry Gonzalez, D-Tex., regarding the recent collapse of Community Bankers U.S. Government Money Market Fund and reports of other banks that had been forced to infuse substantial amounts of cash into affiliated mutual funds following major losses from investments m structured notes.
"In the event a bank holding company were to provide support to a proprietary money market mutual fund in a manner that was deemed to be an unsafe or unsound transaction, the Federal Reserve's existing supervisory authority is sufficient to address the situation," Greenspan said in the letter to the chairman of the House Banking Committee.
"Our overall assessment of this area leads us to conclude that there is not an inordinate financial risk associated with mutual fund activities of banking organizations and that none of the specific transactions we reviewed was unsafe or unsound," Greenspan said in the letter.
Greenspan, in his response to Gonzalez, provided seven examples of bank holding companies that had added a total of about $129 million to affiliated money market funds to make up for losses suffered from investments in structured notes. Those companies ranged from BankAmerica and Bankers Trust to Northern Trust and Norwest Corp.
However, Greenspan said the losses reported didnit represent an overall risk to the industry.
"None of these instances is considered to have been an unsafe or unsound transaction," the Federal Reserve said in its staff paper provided to Gonzalez. 'The losses incurred by the bank holding companies, all of which are large, well-capitalized institutions, had only a minimal effect on their respected financial condition and capital levels."
Despite the Federal Reserve's response, Gonzalez still expressed concern over bank investment in the structure notes.
"While the bank holding companies and their affiliate funds were lucky in avoiding disaster this time because the companies were all well-capitalized, fund investors may not always be so lucky," Gonzalez said in a statement released yesterday.
In a separate report released by the Working Group on Financial Markets, deputy Treasury secretary Frank Newman reiterated the long-standing position of federal regulators that broad derivatives legislation isn't needed.
The working group, an interagency group set up initially to investigate the 1987 stock market crash, has been working toward coordinated regulation of derivatives and other financial issues.
"It is not the goal of the government to shield all market participants from risks," Newman told reporters yesterday. He emphasized the need for proper disclosure and suitability standards, which are efforts regulators have improved and continue to work on.
"We haven't identified any areas of significance that would call for broad legislation," Newman said. "The notion that derivative activity is unregulated is not accurate."
Newman said many derivatives, including mortgage-backed securities or exchangetraded options, are regulated. He added that most of the major dealers and many users are subject to regulatory oversight.
Newman said government agencies have taken a number of important actions in overseeing derivatives investments. For example, bank regulatory agencies have issued new guidelines to banks and examiners detailing new standards for internal controls and risk management.
In addition, accounting and disclosure standards are being revised by the Financial Accounting Standards Board, a private sector standard-setting board, and the Securities and Exchange Commission.
However, Newman said the efforts of the working group represent an ongoing activity and the group may find the need for changes in regulation.
"Financial markets continue to change rapidly and we should be prepared to address new developments," Newman told reporters.
Securities and Exchange Commission chairman Arthur Levitt, who also has insisted that the SEC has the tools it needs to oversee derivatives, warned on Wednesday that such financial instruments pose risks and emphasized the need for improved disclosure and accounting.
"The huge size of this unregulated and largely non-transparent market not only presents issues for individual companies, but also can have implications for the soundness of entire financial systems," Levitt said in remarks before the International Organization of Securities Commissions.
"Market participants, as well as regulators, have recognized that increased transparency for derivatives is of the highest priority," Levitt said.
