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Greenspan hits back at buffett warnings Original Source Link: (May no longer be active)
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2003/05/09/cngreen09.xml&menuId=242&sSheet=/money/2003/05/09/ixfrontcity.htmlhttp://www.telegraph.co.uk/money/main.jhtml?xml=/money/2003/05/09/cngreen09.xml&menuId=242&sSheet=/money/2003/05/09/ixfrontcity.html
Greenspan hits back at Buffett warnings
By Simon English in New York (Filed: 09/05/2003)
Alan Greenspan yesterday took issue with apocalyptic warnings by billionaire investor Warren Buffett about derivatives, arguing that the complex financial instruments had reduced the severity of the global recession.
Mr Buffett, the world's second richest man after Bill Gates, cautioned recently that derivatives were "financial weapons of mass destruction" that posed a grave risk to the stability of the banking system."
In a speech yesterday Mr Greenspan, the 77-year-old chairman of the US Federal Reserve, acknowledged the fears, but noted: "Even the largest corporate defaults in history - WorldCom and Enron - and the largest sovereign default in history - Argentina - have not significantly impaired the capital of any major financial intermediary. The benefits of derivatives, in my judgment, have far exceeded the costs."
Derivatives range from simple bets on the future price of a commodity such as coffee to elaborate and unregulated deals used by banks to spread risk. These contracts have played a part in financial catastrophes at Barings Bank, Long-Term Capital Management and Enron.
In each case, management misunderstood or ignored the inherent risks of what they thought was a winning formula. Mr Buffett's concern is that a small number of banks have offset massive risks with each other, meaning that, if one party fails, the others collapse. He described a "daisy chain risk" from contracts devised by "madmen".
No one really knows the true size of the derivatives market, though one estimate is that the total value of the unregulated deals has risen to $127 trillion from $3 trillion in 1990.
Mr Greenspan argues for better disclosure by institutions but says derivatives have actually lowered risk during a time of great economic strain, producing "a far more flexible, efficient and resilient financial system than existed just a quarter century ago."
Both men are regarded as sages - their views are perhaps more closely watched than those of any other people in finance. One reason for the difference of opinion could be that Mr Buffett has lost many millions of dollars on derivatives after buying the General Re insurance company.
General Re's derivatives arm has been shut down but the liabilities will exist for years, leading Mr Buffett to remark that derivatives are like hell, "easy to enter and almost impossible to exit".
In a speech to a conference, Mr Greenspan countered that the "remarkable resilience" of the US economy in the face of terror attacks and a stock market crash is due to banks being able to manage risk better and therefore keep credit markets open.
"Economic growth has been sub par for some time, but we seem to have experienced a significantly milder downturn that the long history of business cycles and the severity of the shocks to the economy would have led us to expect," he said.
By unbundling risks, banks have lowered the chances of a major collapse, he argued, noting that losses on derivatives occur at a smaller rate than losses on commercial loans.
Last month, President Bush said Mr Greenspan deserved another term as chairman of the Fed when his contract expires next year. This was seen in political circles as a shrewd attempt to patch up a relationship that was strained when Mr Greenspan criticised Mr Bush's tax cuts.
• Minutes released yesterday from the last Fed board meeting showed the bank is worried about the risk of deflation.
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