Haunting Words from the Federal Reserve

For all that has been leveled at former Federal Reserve Chairman Alan Greenspan's contribution to the current financial crisis, very little has been noted about the current Federal Reserve Chairman's contribution.  Mr. Greenspan has been vilified for his comments in 2004 supporting the use of adjustable rate mortgages.  Here is what Mr. Bernanke had to say in a 2006 speech about the use of credit default swaps and asset backed securities. 

To an important degree, banks can be more active in their management of credit risks and other portfolio risks because of the increased availability of financial instruments and activities such as loan syndications, loan trading, credit derivatives, and securitization. For example, trading in credit derivatives has grown rapidly over the last decade, reaching $18 trillion (in notional terms) in 2005. The notional value of trading in credit default swaps on many well-known corporate names now exceeds the value of trading in the primary debt securities of the same obligors.  Asset-backed securitization has also provided a vehicle for decreasing concentrations and credit risk in bank portfolios by permitting the sale of loans in the capital markets, particularly loans on homes and commercial real estate.

Given the implosion of the credit default swap and mortgage backed securities markets, Mr. Bernanke's comments seem to be equal if not more impactful than Mr. Greenspan's comments in 2004.   As we now know, the use of these vehicles actually increased risk on a systemic basis rather than lowering it.