Despite convoluted denial by Greenspan and the NY Federal Reserve Bank, moral harzard has been increased with the Fed orchestrated bail-out of LTCM. Incidentally, while the crisis of LTCM was caused by the sudden impact of the Russian default on the normal paradigm of global interest rate parity, the collapse of LTCM, if allowed to occur, would have been many folds the impact of the Russian default. The notional value of LTCM exposure was around US$2 trillion with risk exposure of several hundred billions (no one knew how many). In contrast, the Russian default involved less than US$4 billion. The problem is with the spectacular and unregulated growth of privately traded derivatives, the underlying asset of which (notional value) rose from negligible in 1988 to US$37 trillion in 1998, almost 5 times the GDP of the U.S., by unbundling risks in globalized markets for buyers who will pay the highest price for specific protection. At year-end 1998, U.S. commercial banks, the leading players in global derivatives markets, reported outstanding derivatives contracts with a notional value of $33 trillion, a measure that has been growing at a compound annual rate of around 20 percent since 1990. Of the $33 trillion outstanding at year-end, only $4 trillion were exchange-traded derivatives; the remainder were off-exchange or over-the-counter (OTC) derivatives. An OTC instrument is traded not on organized exchanges (like futures contracts), but by dealers (typically banks) trading directly with one another or with their counterparties (hedge funds) using electronic means. The $2.5 trillion-a-day repurchase agreement, or repo market, is the place where bond firms and investors drum up cash to buy securities, and where corporations and money market funds park billions of dollars daily to lock in attractive returns. It is also the main source for funds by commercial banks for financing derviative trading. I posted an apologetically long post on the subject: The Repo Market Time Bomb, on this list on April 8, 1999. The counter-party credit risk of the global structured finance market is unbelievably fragile and explosive. Henry C.K. Liu Seth Sandronsky wrote: > Friends, > > I read the article below with much concern. A second Russian debt default > could make the meltdown of the Long-Term Capital Management "hedge fund" > look like a walk in the park, no? > > Seth Sandronsky > > Monday May 3 1999 > > HK issues US with hedge-fund warning > > BARRY PORTER in Manila > Hong Kong Monetary Authority chief executive > Joseph Yam Chi-kwong has told the United > States not to put the interests of American > hedge funds and other highly leveraged > institutions ahead of small open markets such > as Hong Kong. > > He warned the US and other economic > powerhouses against stalling proposed reforms > to the world's financial architecture in the wake > of the economic crisis. > > Mr Yam told a gathering of leading > international bankers that the many working > groups set up to review possible global financial > sector changes were taking "too long". > > "There is always the risk that, when the dust > has settled, the initiative and enthusiasm, dare I > say, on the part of those less affected by the > crisis, may be stifled," Mr Yam said in an > address to the Institute of International Finance > in Manila. > > "There is also the risk that the plight of those > who have been seriously affected by the crisis > is not given the attention it deserves, simply > because they do not have an adequately > representative voice on the issues at hand at > these international forums." > > Mr Yam said there had been no lack of ideas, > but these needed to be translated into action > sooner rather than later. > > He said it was clear highly leveraged institutions > acted in a calculated, secretive and potentially > highly destablising way and safeguards were > needed. > > Mr Yam made three suggestions. > > He called for greater transparency of markets, > particularly over-the-counter (OTC) markets, > which, he said, were very opaque and were > where highly leveraged institutions conducted > most of their activities. > > "Unlike ordinary exchanges, OTC markets are > subject to little, if any, transparency or > regulatory requirements, raising the risk of > price-ramping, collusion of misconduct," said > Mr Yam, calling for a better disclosure > framework. > > He said he supported a German proposal for an > international credit register, which would collate > information on the exposures of international > financial intermediaries to large market players > that have a potential to create systemic risk. > > He called for highly leveraged institutions and > hedge funds to be regulated. > > The Basle Committee on Banking Supervision, > a working group of specialists from the Group > of 10 leading industrialised nations, has > recommended indirect regulation whereby > banks adopt more prudent policies on the > assessment and management of their exposure > to such institutions. > > Mr Yam said: "Other tools of indirect > regulation could include the imposition of > capital charges on lending to such institutions, > raising margin and collateral requirements." > > However, he was yet to be convinced that such > indirect measures could adequately protect > smaller markets like Hong Kong from > overwhelming speculative onslaughts. > > Finally, the HKMA chief said there was a need > for international co-operation to tackle > regulatory arbitrage, in order to penalise highly > leveraged institutions trying to escape any new > market environment. > > He suggested higher risk weights for > counter-party transactions for banks doing > business with financial entities operating out of > offshore jurisdictions that did not comply with > Basle core principles. > > However, Mr Yam stressed he was not against > free markets and warned that a delicate > balancing act would be required not to impose > over-heavy reporting burdens or infringe too > much on proprietary information of individual > institutions. > > South China Morning Post Publishers Ltd. > All Rights Reserved. > > _______________________________________________________________ > Get Free Email and Do More On The Web. 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