Regional President Speech

SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 1 I. INTRODUCTION A. IT IS A PLEASURE TO BE HERE AND HAVE A CHANCE TO REVIEW MY THOUGHTS ON THE DERIVATIVES MARKETS WITH YOU. I FIRMLY BELIEVE THAT THESE EXCHANGES BETWEEN REGULATORS AND INDUSTRY PARTICIPANTS SERVE AN IMPORTANT AND MUTUALLY BENEFICIAL PURPOSE AND I THINK A GOOD DEAL HAS BEEN ACCOMPLISHED BY THE RECENT DISCUSSIONS. BUT ON THE OTHER HAND, PERHAPS YOU SHOULD ALL BE A LITTLE UNNERVED AS WELL -- TO PARAPHRASE THE OLD JOKE, "I'M FROM THE FEDERAL RESERVE AND I'M HERE TO HELP." 1. As YOU ARE ALL AWARE, THE DERIVATIVE MARKETS ARE WITHOUT QUESTION THE FASTEST GROWING AND MOST EXCITING AREA IN THE FINANCIAL INDUSTRY, BUT THAT GROWTH IS BEGINNING TO ATTRACT SOME UNWANTED, BUT Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 2 PERHAPS HEALTHY ATTENTION. To PUT IT MILDLY, YOUR PRESS HASN'T BEEN TOO GOOD LATELY. BETWEEN METALGELSELSHAFT, THE RECENT CASE OF GIBSON GREETINGS, THE COVER OF A MAJOR BUSINESS MAGAZINE AND A BLIZZARD OF GOVERNMENT AND INDUSTRY REPORTS, IT SEEMS AS THOUGH EVERYONE IS SUDDENLY WORRIED ABOUT DERIVATIVES. 2. THIS SHOULDN'T COME AS A BIG SURPRISE. THE COMPLEXITY AND RAPID PACE OF CHANGE IN THESE MARKETS HAS SIMPLY OUTSTRIPPED THE ABILITY OF ALL BUT THE SPECIALISTS TO KEEP UP. 3. EVEN SOPHISTICATED INDIVIDUALS CAN FEEL OVERWHELMED WHEN CONFRONTED WITH CONCEPTS SUCH AS DIGITAL AND IMBEDDED OPTIONS, SWAPTIONS, CAPS AND COLLARS, AND THE SEEMINGLY ENDLESS VARIETY OF Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 3 CLEVER NEW COMBINATIONS. IT'S EASY TO UNDERSTAND WHY AN OUTSIDER, OR MORE TO THE POINT, A LEGISLATOR, WOULD FIND THESE MARKETS CONFUSING AND PERHAPS EVEN SINISTER. 4. As MY VIEWPOINT IS SOMEWHAT DIFFERENT. A CENTRAL BANKER, MY CONCERN IS NOT SO MUCH WITH THE COMPLEXITY OF THE MARKET, BUT WITH ITS UNDERLYING INTEGRITY. THE FEDERAL RESERVE, AS THE NATION'S CENTRAL BANK, HAS THE ULTIMATE RESPONSIBILITY FOR THE HEALTH AND EFFICIENT OPERATION OF THE FINANCIAL SYSTEM. IN THAT ROLE OUR JOB IS NOT TO ELIMINATE RISK, BUT IN CASES WHERE THERE ARE CONFLICTS, TO MAKE TRADE-OFFS BETWEEN RISK AND EFFICIENCY. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 4 B. HAVING SAID THAT, LET ME STATE AND EMPHASIZE THAT THERE IS NO QUESTION IN MY MIND BUT THAT DERIVATIVES PLAY A USEFUL ROLE IN MODERN FINANCIAL STRATEGIES. TODAY, IT IS POSSIBLE -- TO AN EXTENT THAT WOULD HAVE BEEN HARD TO IMAGINE TWENTY YEARS AGO FOR A FIRM TO SEPARATE DIFFERENT RISKS - CURRENCY, INTEREST RATE AND COMMODITY SELL OFF THOSE RISKS WHICH THE FIRM DOESN'T WANT TO RETAIN AND KEEP THOSE IT DOES. THE FLEXIBILITY AND LOW COST OF THESE PRODUCTS HAVE ALLOWED FIRMS TO MANAGE RISK AND PURSUE NEW BUSINESS IN WAYS THAT WERE SIMPLY IMPOSSIBLE IN EARLIER TIMES. THE VERY REAL AND SIGNIFICANT ADVANTAGES OF THESE FINANCIAL STRATEGIES HAVE DEMONSTRATED THEMSELVES DRAMATICALLY IN THE MARKET PLACE. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 5 1. BUT THERE ARE LEGITIMATE CONCERNS THAT HAVE DEVELOP -- AND REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY AND HIGH GROWTH RATES AND HIGH CONCENTRATIONS ARE TWO HOT BUTTONS THAT ALWAYS GET OUR ATTENTION. 2. ONE NEED HARDLY REPEAT THE STANDARD, IF ADMITTEDLY FLAWED NUMBERS, ABOUT THE INCREDIBLE GROWTH IN DERIVATIVE ACTIVITIES TO UNDERSTAND WHY THERE ARE CALLS FOR SIGNIFICANT REGULATORY CONTROLS. 3. 1992, fOR THE FIVE-YEAR PERIOD ENDING IN THE NOTIONAL VALUE OF SWAP CONTRACTS THEN OUTSTANDING HAD INCREASED FROM AN $865 ESTIMATED BILLION TO SOME $4.7 TRILLION. THIS COMPARES TO A TOTAL $3.6 OF TRILLION IN THE TOTAL OF Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 6 U.S. CORPORATE DEBT OUTSTANDING IN THE WITHIN THE BANKING SYSTEM, THE USE OF SWAPS OVER THIS SAME PERIOD INCREASED FROM A NOTIONAL VALUE OF $705 BILLION TO $2.1 TRILLION, A LEVEL EQUIVALENT TO SEVEN TIMES THE AGGREGATE AMOUNT OF BANK CAPITAL. 4. THESE GROWTH NUMBERS ARE MATCHED BY EVEN MORE WORRISOME CONCENTRATIONS OF RISK IN THE DEALER MARKET. ACCORDING TO THE 1993 SWAPS MONITOR SURVEY, THE TEN LARGEST DEALERS ACCOUNT FOR ABOUT HALF OF THE OUTSTANDING INTEREST RATE SWAPS. AND THE TEN LARGEST DEALERS IN CURRENCY 40 SWAPS ACCOUNT FOR PERCENT OF THE MARKET. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN & INTERNATIONAL SWAPS DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" 18, 1994 - 7 MARCH PAGE 5. SUCH NUMBERS, EVEN IF SOMEWHAT OVERSTATED, HAVE AN UNFORTUNATE RESONANCE WITH PREVIOUS PROBLEMS IN THE FINANCIAL SYSTEM. As THE HISTORICAL RECORD DEMONSTRATES OVER AND OVER AGAIN, HIGH GROWTH AND UNDUE CONCENTRATION OF RISK ARE A RECIPE FOR TROUBLE. II. LENDING TO LESSER DEVELOPED COUNTRIES IN THE '70s IS A GOOD EXAMPLE. A. WHILE ADVERTISED BY SOME AS A WAY OF RECYCLING THE MASSIVE INFLOW OF PETRO DOLLARS -- IT WAS ALMOST THE PATRIOTIC THING TO DO -- THAT ARGUMENT WAS LESS THAN COMPELLING. B. IN THE LIGHT OF HINDSIGHT, BANKERS UNDERESTIMATED THE RISKS AND SAW AN ALLUSIVE OPPORTUNITY TO INCREASE EARNINGS BY AGGRESSIVELY EXPANDING THEIR LDC LENDING. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 8 1. ANOTHER CLASSIC EXAMPLE WAS THE ENERGY AREA -- A. IF YOU GO BACK TO THE PERIOD WHEN ENERGY LENDING REALLY BEGAN TO ESCALATE, BANK MANAGEMENTS WERE CONVINCED THAT IT WAS AN APPROPRIATE WAY TO BUILD UP EARNING ASSETS AT COMPARATIVELY HIGH RATES OF RETURN AND WITH LITTLE PERCEIVED RISK. UNFORTUNATELY FOR THOSE BANKS AND ALSO FOR THE DEPOSIT INSURANCE AGENCIES, IT TURNED OUT THAT ENERGY PRICES COULD GO DOWN AS WELL AS UP. B. ONCE AGAIN, HIGH GROWTH COMBINED WITH AN INSUFFICIENT APPRECIATION OF THE RISKS INVOLVED LED TO DISASTROUS RESULTS FOR MANY BANKS. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN & INTERNATIONAL SWAPS DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" 18, 1994 - 9 MARCH PAGE C. I AM NOT SAYING THAT VERY RAPID GROWTH PER SE IS NECESSARILY FATAL, BUT RATHER IT IS SIMPLY A WARNING SIGNAL. As GROWTH ACCELERATES, EVEN SMALL MISTAKES CAN GROW INTO MAJOR PROBLEMS. C. [BENEFITS] 1. BUT BEFORE THE PARALLELS BETWEEN THE GROWTH IN DERIVATIVES AND LDC AND ENERGY LENDING BECOME OVERDRAWN, IT IS, FIRST, IMPORTANT TO REMEMBER THAT NOTIONAL VALUE IS AT BEST ONLY A ROUGH GUIDE TO THE TRUE SIZE OF THE MARKET AND THE ACTUAL RISKS THAT ARE BEING UNDERTAKEN. BETTER DATA BASED ON MARKET VALUE AND SEGMENTED BY TYPE OF CONTRACT, ADJUSTED FOR DOUBLE COUNTING AND NETTING, ARE CLEARLY NECESSARY IN ORDER TO BE ABLE TO Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 10 UNDERSTAND THE ACTUAL RISK EXPOSURES THAT HAVE DEVELOPED IN THESE MARKETS. A. SECONDLY, IT IS IMPORTANT TO REMEMBER THAT DERIVATIVES ARE PRIMARILY A RISK MANAGEMENT TOOL, NOT A RISK ACQUISITION TOOL -- AND THAT EVEN A SIGNIFICANT DERIVATIVE RISK OF AN INDIVIDUAL INSTITUTION MIGHT ONLY BE OFFSETTING AN EQUIVALENT BUT OPPOSITE RISK IN THE REST OF THEIR PORTFOLIO. 2. THIS IS NOT TO SAY THAT THERE AREN'T ANY RISKS, BUT RATHER THAT MUCH OF THE RISK THAT IS ASSOCIATED WITH DERIVATIVES ARISES NOT FROM THEIR EXISTENCE BUT FROM THEIR POSSIBLE MISUSE -- A VERY A IMPORTANT DISTINCTION. PRODUCT THAT ALLOWS FIRMS TO QUICKLY AND EASILY Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 11 ELIMINATE LARGE RISKS ALSO ALLOWS THEM TO ACQUIRE THOSE RISKS AND THUS IN TURN, TO EXPOSE OTHERS IN THE SYSTEM. THIS RAISES BOTH COUNTER-PARTY AND SYSTEMIC ISSUES THAT THE FEDERAL RESERVE, WHICH HAS THE ULTIMATE RESPONSIBILITY FOR THE INTEGRITY OF THE FINANCIAL SYSTEM, CANNOT IGNORE. 3. AND CERTAINLY THE MARKET UNDERSTANDS THESE ISSUES. THE DEVELOPMENT OF TRIPLE-A RATED SUBSIDIARIES, AS WELL AS THE HIGH CAPITAL AND COLLATERAL REQUIREMENTS THAT THE MARKET IS DEMANDING OF DEALERS IS CLEAR EVIDENCE OF JUST HOW SERIOUSLY THE MARKET TAKES THESE RISK-MANAGEMENT ISSUES. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 12 4. fROM THE STANDPOINT OF CENTRAL BANKERS, SUCH PRUDENCE AMONG CUSTOMERS IS A GOOD SIGN THAT THE MARKET IS WORKING AND IS MANAGING RISK ON ITS OWN. l'M NOT AWARE THAT ANY BORROWER HAS EVER REQUIRED THAT A BANK HAVE A TRIPLE-A CREDIT RATING BEFORE ACCEPTING AN ENERGY LOAN FROM THEM. D. BUT WE NEED TO AVOID BURDENSOME REGULATION 1. BOTH BASED ON OUR SUPERVISION OF INDIVIDUAL BANKS AND AS WELL AS OUR RESEARCH, IT'S OUR JUDGEMENT THAT BANKS ARE USING DERIVATIVES TO BETTER MANAGE RISK AND THAT IF ANYTHING, THE GROWTH IN DERIVATIVES REPRESENTS A POSITIVE DEVELOPMENT IN TERMS OF OVERALL PORTFOLIO RISK MANAGEMENT. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 13 A. AND IT IS THIS BELIEF THAT DRIVES ME I TO TRY TO MAKE CLEAR TO YOU WHAT THINK IS NECESSARY IF THESE MARKETS ARE GOING TO BE ALLOWED TO CONTINUE TO GROW AND DEVELOP WITHOUT SIGNIFICANT AND POTENTIALLY BURDENSOME REGULATION BEING IMPOSED FROM THE OUTSIDE. B. WITH THAT IN MIND, LET ME COMMENT ON I THE CHANGES THAT THINK ARE NECESSARY ON THE PART OF THE INDUSTRY, THE FEDERAL RESERVE AND OTHERS IF THESE MARKETS ARE GOING TO BE ALLOWED TO CONTINUE TO INNOVATE AND TO MEET THE MARKETS' GROWING DEMAND FOR RISK-MANAGEMENT TOOLS. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 14 C. THE CRITICAL QUESTION WE NEED TO ANSWER, ONE THAT REALLY NEEDS TO BE EMPHASIZED, IS HOW BEST TO DEAL WITH THE REAL AND PERCEIVED RISKS POSED BY THESE MARKETS IN A WAY THAT WILL ALLOW THE INNOVATION NECESSARY TO COMPETE IN THIS VERY COMPETITIVE MARKETPLACE AND YET PROTECT THE SYSTEM FROM MAJOR DISRUPTIONS. Ill. [SUPERVISION V. REGULATION] A. IN MY VIEW, A KEY TO MEETING THIS GOAL IS TO UNDERSTAND THE DIFFERENCE BETWEEN REGULATION AND SUPERVISION. 1. WHILE SOME TEND TO USE THESE WORDS SOMEWHAT INTERCHANGEABLY, LET ME POINT OUT THE DISTINCTION BETWEEN THE TWO WHICH I THINK IS VERY IMPORTANT. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 15 2. SUPERVISION IS INSTITUTION SPECIFIC AND RELIES HEAVILY ON THE INDUSTRY AND THE INSTITUTION TO DEFINE AND FOLLOW GOOD BUSINESS PRACTICE. IT IS THE FUNDAMENTAL ELEMENT IN THE EXAMINATION PROCESS. 3. REGULATION RELIES ON RULES TO PREVENT 11BAD PRACTICES." IN MY EXPERIENCE, REGULATION IN RAPIDLY EVOLVING MARKETS IS EITHER TOO LITTLE TOO LATE - FREQUENTLY OVER-REACTING AFTER THE PROBLEMS HAVE ALREADY DEVELOPED -- OR TOO MUCH TOO SOON -- STIFLING INNOVATION AND HAMPERING THE MARKET'S ABILITY TO PROVIDE NEEDED SERVICES. A. WHILE ADMITTEDLY A POSSIBLE OVER-GENERALIZATION, I THINK THAT FOR ALMOST ANY FINANCIAL ACTIVITY, Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 16 THE MORE THAT OFFICIAL REGULATION CAN BE DISPLACED BY EFFECTIVE SUPERVISION AND INDUSTRY STANDARDS, THE BETTER OFF THE FINANCIAL SYSTEM WILL BE. I B. BUT ON THE REGULATORY SIDE, WOULD URGE THAT THE INDUSTRY PROVIDE FOR SELF-REGULATION TO THE GREATEST EXTENT POSSIBLE. You (I) KNOW THE COMPETITIVE REQUIREMENTS OF YOUR MARKETS AND THE CURRENT AND FUTURE NEEDS OF YOU CUSTOMERS BETTER THAN WE DO AND YOU ARE IN A BETTER POSITION TO ASSESS THE OPERATIONAL IMPLICATIONS OF ALTERNATIVE SYSTEMS OF CONTROL. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN & INTERNATIONAL SWAPS DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" 18, 1994 - 17 MARCH PAGE (11) I WOULD ALSO URGE THAT YOU CONTINUE TO DEVELOP AND IMPROVE STANDARDS (REGULATIONS) WHICH WILL PROVIDE FOR SAFETY AND SOUNDNESS IN THESE ACTIVITIES. THE GROUP OF THIRTY REPORT WAS A GOOD FIRST STEP, BUT ONLY A FIRST STEP. EVENTUALLY, THE RULES WILL NEED TO BE FAR MORE SPECIFIC. (111) AND THERE NEEDS TO BE AN INDUSTRY SELF-POLICING SYSTEM THAT HAS TEETH AND WHICH WILL, THROUGH ITS ACTIONS, BE RESPECTED. CLEARLY THE ISDA HAS AN IMPORTANT ROLE TO PLAY IN THIS PROCESS. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 18 (IV) SUCH AN ORGANIZATION WILL SIGNIFICANTLY LESSEN THE NEED FOR RESTRAINING REGULATIONS BEING IMPOSED BY EXTERNAL SOURCES, A VERY REAL DANGER AS LONG AS THESE MARKETS ARE VIEWED BY SOME, NO MATTER HOW UNFAIRLY, AS FREE WHEELING GAMBLING CASINOS. (v) IN THIS LIGHT I WOULD ALSO SUGGEST THAT THE INDUSTRY SHOULD SPEND MORE TIME DISCUSSING THE REAL ECONOMIC BENEFITS DERIVED FROM THE USE OF DERIVATIVES AND DEPEND LESS ON THE GENERAL DEFENSE OF THE NEED TO COMPETE. THIS WILL HELP MAKE MUCH CLEARER THE Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN & INTERNATIONAL SWAPS DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" 18, 1994 - 19 MARCH PAGE TRADE-OFFS IMPLICIT IN RESTRICTING THESE ACTIVITIES. 4. THE FEDERAL RESERVE HAS BEEN ACTIVELY DOING WHAT WE CAN TO HELP. WE HAVE CONSISTENTLY PROMOTED THE DEVELOPMENT OF INDUSTRY GROUPS AS WELL AS PROVIDING THESE INSTITUTIONS WITH THE NECESSARY LEGISLATIVE AND REGULATORY TOOLS TO HELP THEM MANAGE THE RISKS ON THEIR OWN. A. FOLLOWING FIRREA, WHICH ALTERED THE TREATMENT OF DERIVATIVES FOR BANKRUPT INSTITUTIONS COVERED BY DEPOSIT INSURANCE, B. THE FEDERAL RESERVE, AMONG OTHERS, SOUGHT AND WAS ABLE TO ACHIEVE SIGNIFICANTLY BROADER AND MORE LEGALLY SECURE TREATMENT OF NETTING AGREEMENTS UNDER FDICIA. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN & INTERNATIONAL SWAPS DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 20 C. FURTHER, FDICIA EXTENDED NETTING TO SECURITIES BROKERS, DEALERS AND NON BANK PARTICIPANTS ON CHIPS, AS WELL AS APPROPRIATE FINANCIAL INSTITUTIONS AS DETERMINED BY THE FEDERAL RESERVE. D. ON FEBRUARY FIRST OF THIS YEAR WE RELEASED THE FINAL RULES FOR USE IN DETERMINING WHICH INSTITUTIONS WILL BE COVERED BY THE FDICIA NETTING PROVISIONS AND THESE NEW RULES TOOK EFFECT ON MARCH 7TH. E. As A RESULT OF THESE ACTIONS, IT WILL BE SUBSTANTIALLY EASIER FOR FIRMS TO MANAGE THEIR CREDIT RISKS AND TO RESOLVE INSOLVENCY PROBLEMS IN THESE MARKETS IN THE FUTURE. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 21 F. WE HAVE ALSO RECENTLY APPROVED AN EXTENSION OF THE HOURS THAT OUR WIRES FOR MOVING FUNDS ELECTRONICALLY WILL BE OPEN IN ORDER TO REDUCE TEMPORAL RISK AND TO ALLOW INSTITUTIONS TO WORK AT REDUCING THE I HERSTATT RISK. AM PLEASED TO SAY THAT THE CHICAGO fED PLAYED A MAJOR ROLE IN PROMOTING THESE CHANGES. I G. ALSO HAVE TO ADMIT TO HAVING BEEN SURPRISED BY THE INDUSTRY'S RESPONSE WHEN THE EXTENDED HOURS PROPOSAL WAS GOING THROUGH THE COMMENT PHASE, (I) PARTICULARLY IN A CHICAGO I CONTEXT, HAD THOUGHT THAT THIS SHOULD BE ENTHUSIASTICALLY SUPPORTED. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN & INTERNATIONAL SWAPS DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" 18, 1994 - 22 MARCH PAGE (II) BUT FRANKLY, THE COMMENTS THAT WE RECEIVED WERE UNDER-WHELMING. 5. BEYOND FEDERAL RESERVE ACTIONS, THERE IS A LOT TO DO IN TERMS OF THE FUNCTIONING OF MARKET MECHANISMS AND JUST AS IMPORTANTLY, IMPROVING THE PUBLIC'S PERCEPTION OF THESE MARKETS, IF THEY ARE GOING TO BE FREE TO PROSPER IN THE FUTURE. A. AT THE BROADEST LEVEL, I THINK WE NEED TO SEE BETTER ACCOUNTING STANDARDS. HOPEFULLY, FASB's NEW RECOMMENDATIONS ON DERIVATIVES AND HEDGE ACCOUNTING WILL BE A SIGNIFICANT FIRST STEP IN THIS DIRECTION. WELL DESIGNED ACCOUNTING STANDARDS WILL SUBSTANTIALLY AID Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 23 BOTH THE SUPERVISORS' AND THE MARKET'S ABILITY TO MONITOR THESE ACTIVITIES. IF MARKET DISCIPLINE RATHER THAN REGULATION IS TO PROVIDE THE BASIC CONTROL MECHANISM FOR THESE MARKETS, IT IS IMPERATIVE THAT FINANCIAL REPORTING PROVIDES THE NECESSARY INFORMATION TO MAKE AS INFORMED ASSESSMENTS AS IS POSSIBLE. B. GOOD FINANCIAL REPORTING STANDARDS WITH EXTENSIVE DISCLOSURE CAN HELP REASSURE THE MARKETS THAT DERIVATIVES ARE IN FACT ASSISTING FINANCIAL INSTITUTIONS AND CUSTOMER FIRMS TO BETTER MANAGE THEIR RISKS RATHER THAN ALLOWING THEM TO GAMBLE WITH THEIR STOCKHOLDERS' MONEY. ALSO, IT IS Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 24 WITH GOOD ACCOUNTING PRACTICES THAT WE WILL BE ABLE TO GET A BETTER HANDLE ON THE APPROPRIATE TAX TREATMENT OF DERIVATIVE ACTIVITIES. C. SUCH CHANGES WILL ALLOW MARKET PARTICIPANTS, SUPERVISORS AND LEGISLATORS TO BETTER UNDERSTAND AND MONITOR THE MARKETS AND WILL ALSO PROVIDE A BASIS FOR THE OUTSIDE AUDITING OF THESE ACTIVITIES. BUT THIS IS NOT THE WHOLE SOLUTION SINCE SUCH ACCOUNTING INFORMATION IS ONLY AVAILABLE AT SPECIFIC POINTS IN TIME. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 25 D. THE STRENGTH AND WEAKNESS OF THE DERIVATIVES MARKET IS THAT IT ALLOWS INSTITUTIONS TO RADICALLY CHANGE THEIR MARKET EXPOSURE IN VIRTUALLY NO TIME. BUT THIS ADVANTAGE MUST BE SUPPORTED BY THE DEVELOPMENT AND ENFORCEMENT OF INTERNAL PROCEDURES WITHIN INDIVIDUAL INSTITUTIONS SO THAT PROBLEMS DO NOT DEVELOP IN-BETWEEN FINANCIAL STATEMENTS. IV. WITH THIS AS A LEAD-IN, LET ME SHIFT FROM BROAD INDUSTRY CONCERNS TO SOME IMPORTANT INSTITUTION-SPECIFIC ISSUES. A. To LIMIT THE DEVELOPMENT OF POTENTIALLY DAMAGING PROBLEMS, THERE ARE SOME ABSOLUTELY ESSENTIAL ELEMENTS THAT MUST BE A PART OF ANY ORGANIZATION'S BASIC THINKING. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 26 1. FIRST RISK MEASUREMENT SYSTEMS ARE PARAMOUNT. A. THE INSTITUTION SIMPLY HAS TO KNOW AND ON A CURRENT BASIS THE MAGNITUDE OF THE RISKS THAT ARE GOING ONTO THEIR BOOKS. B. FOR MANY OF THE NEWER PARTICIPANTS IN THESE ACTIVITIES THIS MAY SEEM VERY COMPLICATED, BUT WITHOUT A GOOD RISK MEASUREMENT SYSTEM AN INSTITUTION IS BOUND TO GET INTO VERY SERIOUS TROUBLE. 2. SECOND REALLY EFFECTIVE CONTROLS NEED TO BE IN PLACE. A. MANAGEMENTS NEED TO ESTABLISH LIMITS FOR VARIOUS CATEGORIES OF RISK AND THE CONTROLS DEALING WITH THESE RISKS MUST BE EFFECTIVE. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 27 3. THIRD THERE MUST BE CLEAR ORGANIZATIONAL SEPARATION FOR THOSE GENERATING THE RISKS (THE MARKETING OR SALES SIDE OF THE BUSINESS) FROM THOSE APPROVING THE RISKS OR CHANGING THE LIMITS FOR INDIVIDUAL CATEGORIES. A. WHILE THIS MAY SEEM PRETTY BASIC, THERE HAVE BEEN ANY NUMBER OF EXAMPLES OF BANKS THAT HAVE GOTTEN INTO TROUBLE -- SOMETIMES FATAL BECAUSE THEY HAVE NOT HAD THE EFFECTIVE SEPARATION OF THESE TWO FUNDAMENTAL ASPECTS OF THE CREDIT OR RISK EXTENSION PROCESS. 4. FOURTH THE MANAGEMENT INFORMATION SYSTEMS HAVE TO BE ACCURATE, UNDERSTANDABLE AND CURRENTLY AVAILABLE AT SENIOR LEVELS OF THE ORGANIZATION. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS &D ERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 28 A. WITH ACTIVITIES THAT ARE EVOLVING AT VERY GREAT SPEEDS LIKE DERIVATIVES, A 2OO-PAGE REPORT TWO WEEKS AFTER THE FACT JUST WON'T DO. A B. REAL TIME EXPOSURE MONITORING SYSTEM OR AT THE VERY LEAST AN END OF THE DAY MONITORING SYSTEM THAT PROVIDES ACCURATE, UNDERSTANDABLE REPORTS OF RISK AND EXPOSURE MEASUREMENT TO SENIOR MANAGEMENT IS A SINE QUA NON. 5. FIFTH FOR ANY OF THIS TO WORK IN PRACTICE, IT IS NECESSARY THAT SENIOR MANAGEMENT REALLY HAS A FUNDAMENTAL UNDERSTANDING OF THESE DERIVATIVE ACTIVITIES. A. CHOOSING THE RIGHT PEOPLE TO WORK IN AND MANAGE THESE AREAS IS IMPORTANT, BUT IT IS NOT ENOUGH. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 29 B. IT IS TOO EASY AND FAR TOO SIMPLISTIC TO VIEW DERIVATIVES AS A PURELY SPECIALIZED FUNCTION THAT THE SPECIALISTS CAN BE TRUSTED TO DO RIGHT. (I) FOR SOME I WILL ADMIT THAT ESOTERIC DERIVATIVE ACTIVITIES ARE VERY COMPLEX AND VERY CHALLENGING, C. BUT AS A MANAGEMENT PRECEPT, IT JUST MAKES SENSE THAT IF YOU DON'T UNDERSTAND IT, DON'T GET INVOLVED IN IT. As D. A RELATED MANAGEMENT ISSUE, AND A THOUGHT THAT WILL PROBABLY STRIKE THIS GROUP AS TOTALLY UNACCEPTABLE, IF I WERE IN THE SENIOR MANAGEMENT OF AN Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 30 ORGANIZATION DEALING HEAVILY IN THESE ACTIVITIES, I'D WATCH THE COMPENSATION SCHEMES THAT ARE IN PLACE VERY CAREFULLY. WHILE BONUS AND INCENTIVE PLANS THAT ARE DRIVEN BY THE INSTITUTION'S OVERALL SUCCESS ARE APPROPRIATE AND BENEFICIAL, THOSE THAT PROVIDE FOR VERY HEAVY INCENTIVE MOTIVATION ON A HIGHLY INDIVIDUAL BASIS ALMOST REGARDLESS OF THE INSTITUTION'S TOTAL RESULTS ARE FRAUGHT WITH PERIL. E. FINALLY, I ALSO THINK ITS IMPORTANT FOR THE INDUSTRY TO DEVELOP OUTSIDE AUDITING STANDARDS FOR A FIRM'S RISK MANAGEMENT PROCEDURES. PRUDENT Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 31 MANAGEMENT PRACTICE, AS WELL AS THE DEMANDS OF PUBLIC AND INVESTOR CONFIDENCE, WILL REQUIRE THAT SUCH AUDITS BE DONE IN A CREDIBLE AND REGULAR FASHION. V. MOVING BEYOND SELF-REGULATION, A. EVEN WITH THE BEST CONTROL MECHANISMS AND PROCEDURES IN PLACE, THERE ARE STILL CONCERNS AT BOTH THE INSTITUTIONAL AND SYSTEM LEVEL, ISSUES THAT WE AT THE FEDERAL RESERVE, WHO IN MY VIEW HAVE THE ULTIMATE RESPONSIBILITY FOR THE INTEGRITY OF THE FINANCIAL SYSTEM, CANNOT IN GOOD CONSCIENCE IGNORE, PARTICULARLY THOSE THAT RELATE TO THE INTEGRITY OF THE PAYMENTS MECHANISM -- THE PIPELINE THROUGH WHICH OUR ENTIRE ECONOMY FLOWS. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 32 1. DERIVATIVES AND OTHER INNOVATIONS IN THE FINANCIAL INDUSTRY HAVE GENERATED AN EXPLOSION IN THE FLOWS THROUGH THE PAYMENTS SYSTEM. WHAT WAS ONCE A SIMPLE LOAN INVOLVING MONTHLY PAYMENTS BETWEEN TWO PARTIES CAN TURN INTO A VERITABLE PARADE STARTING WITH A LOAN, AN INTEREST RATE SWAP, AND MAYBE A CURRENCY SWAP. THE LOAN CAN THEN BE SOLD-OFF DIRECTLY OR SECURITIZED, EACH OF THESE CONTRACTS IN TURN MAY SPUR OFFSETTING HEDGES ON THE PART OF THE FINANCIAL INTERMEDIARIES, OR SECONDARY LOANS AS THE PIECES ARE SOLD OFF TO INVESTORS. To GET SOME IDEA OF THE POTENTIAL SYSTEMIC IMPLICATIONS OF THIS EXPLOSION IN Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN & INTERNATIONAL SWAPS DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" 18, 1994 - 33 MARCH PAGE FINANCIAL ACTIVITY, YOU ONLY HAVE TO LOOK AT THE MASSIVE INCREASE IN TRANSACTIONS RUNNING THROUGH THE 1970 PAYMENTS SYSTEM. IN THERE WERE $15 OF FINANCIAL TRANSACTIONS FOR 1980 EVERY DOLLAR OF THE GDP. BY $30 THE RATIO HAD INCREASED TO TO 1990 ONE AND BY THE NUMBER HAD GROWN $78. TO OVER HALF OF THESE TRANSACTIONS ARE CLEARED THROUGH CHIPS WHICH DIDN'T EVEN EXIST IN 1970. AND THIS IS NOT SOLELY A U.S. PHENOMENON. IN JAPAN, FOR EXAMPLE, THE GROWTH IN FINANCIAL TRANSACTIONS HAS BEEN EVEN MORE STAGGERING - 15 GOING FROM A SIMILAR YEN OF FINANCIAL TRANSACTIONS FOR EACH YEN 1970 OF THEIR GDP IN TO A RATIO OF Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN & INTERNATIONAL SWAPS DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 34 115 1990. OVER BY ALMOST ALL OF THE GROWTH HAS BEEN IN LARGE DOLLAR SETTLEMENT SYSTEMS RELATED TO SECURITIES AND FOREIGN EXCHANGE TRANSACTIONS. 8. ONE CAN ONLY IMAGINE THE TYPE OF CHAOS THAT WOULD ENSUE IF ANYTHING SERIOUSLY IMPEDED THESE RAPID MOVEMENTS OF MONEY IN WHICH THE EQUIVALENT OF OUR ANNUAL GDP FLOWS EVERY THREE BUSINESS DAYS. 1. CLEARLY, THERE IS SUFFICIENT RISK HERE TO WARRANT CAREFUL MONITORING AND EXTREME CARE ON THE PART OF FEDERAL RESERVE TO MAKE SURE THAT NO SINGLE FAILURE OR PATTERN OF FINANCIAL ENTANGLEMENTS CAN SERIOUSLY DAMAGE THE PAYMENTS SYSTEM. AND IT IS PRECISELY THIS Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 35 RISK THAT CLEARLY AND DRAMATICALLY EXPLAINS WHY THE FEDERAL RESERVE REMAINS SO INTERESTED IN THE ORDERLY DEVELOPMENT OF THE FINANCIAL SYSTEM AND WHY WE CONTINUE TO ARGUE THAT OUR RESPONSIBILITY FOR MONETARY POLICY AND FOR THE UNDERLYING STABILITY OF THE FINANCIAL SYSTEM IMPLIES A DIRECT AND CONTINUING ROLE IN THE SUPERVISION AND REGULATION OF MAJOR PLAYERS. VI. [CONCLUSION ON SUPERVISORY RESPONSIBILITIES OF FEDERAL RESERVE] A. LET ME CONCLUDE ON THIS SUPERVISORY NOTE WITH A FEW COMMENTS ABOUT THE FED'S ROLE IN DERIVATIVE ACTIVITIES. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 36 1. As YOU KNOW, THE ADMINISTRATION HAS PROPOSED THAT THE CURRENT FEDERAL REGULATORY PROCESS.FOR DEPOSITORY INSTITUTIONS BE CONSOLIDATED INTO A SINGLE AGENCY AND THAT AS A RESULT, THE fED WOULD CEASE TO HAVE SUPERVISORY RESPONSIBILITIES BUT WOULD CONTINUE, OF COURSE, TO HAVE RESPONSIBILITY FOR MONETARY POLICY. 2. I HOPE THAT BY NOW YOU ARE AWARE THAT WE HAVE STRONGLY OBJECTED TO THIS PROPOSAL AND IN TURN, HAVE COUNTER-PROPOSED WITH A STRUCTURE THAT WOULD SIMPLIFY THE CURRENT FRACTIONALIZED SYSTEM AND WHICH FOR MOST INSTITUTIONS WOULD ELIMINATE DUPLICATIVE EXAMINATIONS AND WOULD RESULT IN A SINGLE FEDERAL REGULATOR. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN & INTERNATIONAL SWAPS DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" 18, 1994 - 37 MARCH PAGE 3. I WOULD EMPHASIZE THAT OUR VIEW ON THIS ISSUE STEMS FROM OUR MONETARY POLICY RESPONSIBILITIES AND OUR NEED TO REACT TO A VARIETY OF EVENTS AND CIRCUMSTANCES WITH AN APPROPRIATE MONETARY POLICY RESPONSE. B. As THE NATION'S CENTRAL BANK, THE FEDERAL RESERVE SYSTEM HAS THE OVERRIDING RESPONSIBILITY FOR THE INTEGRITY OF THE FINANCIAL SYSTEM IN ITS MANY DIMENSIONS AND THIS RESPONSIBILITY EXTENDS INTO PARTS OF THE SYSTEM WHERE WE DO NOT HAVE SPECIFIC SUPERVISORY OR REGULATORY AUTHORITY. 1. OVER THE YEARS THAT I HAVE BEEN PRESIDENT OF THE FEDERAL RESERVE BANK OF CHICAGO, I HAVE SEEN ANY NUMBER OF EXAMPLES WHERE THIS Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 38 AUTHORITY AND RESPONSIBILITY, EITHER EXPLICIT OR IMPLICIT, HAS BEEN IMPORTANT IN DEALING WITH SOME 1987 GENUINELY SYSTEMIC ISSUES. IN 1989, AND AGAIN IN BOTH IN CHICAGO AND IN NEW YORK, THE FEDERAL RESERVE THROUGH ITS SUPERVISORY APPARATUS PLAYED AN IMPORTANT ROLE IN MAKING SURE THAT THE FINANCIAL SYSTEM CONTINUED TO FUNCTION. 2. HAPPILY, MOST OF THE INSTANCES THAT COME TO MIND HAVE BEEN INVISIBLE BECAUSE WE WERE ABLE TO CONTAIN THEM BEFORE THEY EXPLODED ONTO THE PUBLIC SCENE. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 39 3. BUT THESE INSTANCES DID HAVE THE POTENTIAL OF BECOMING DAMAGING IN A SYSTEMIC SENSE AND WOULD HAVE BECOME SO HAD WE NOT RESPONDED. C. As YOU WELL KNOW, THE STATE OF THE ART IN DERIVATIVE ACTIVITIES IS LITERALLY ROCKETING AHEAD AT BREATHTAKING SPEED AS DEPOSITORY INSTITUTIONS BECOME MORE HEAVILY INVOLVED IN THESE INCREASINGLY ESOTERIC ACTIVITIES. 1. OUR SUPERVISORY RESPONSIBILITIES, ALREADY VERY COMPLEX, WILL BECOME EVEN MORE SO, BUT BY HAVING THE LEVEL OF INVOLVEMENT THAT WE DO, WE CAN REACH JUDGEMENTS ON THE SAFETY AND SOUNDNESS OF INDIVIDUAL INSTITUTIONS AS WELL AS THE CONTROLS, PROCEDURES AND MANAGEMENT INFORMATION SYSTEMS THAT ARE IN PLACE. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 40 2. THIS INVOLVEMENT IS ESSENTIAL TO MAINTAINING THE INTEGRITY OF THE FINANCIAL SYSTEM WHICH, IN TURN, DIRECTLY RELATES TO OUR OVERRIDING MONETARY POLICY RESPONSIBILITIES. 3. I IN MY VIEW, AND IT'S ONE THAT FEEL VERY STRONGLY ABOUT, THERE IS AN ABSOLUTELY DIRECT INTER-RELATIONSHIP BETWEEN THESE TWO VERY FUNDAMENTAL AND VERY IMPORTANT RESPONSIBILITIES. D. IF ANYTHING, THE INCREASED RATE OF INNOVATION AND INTERCONNECTION BETWEEN MARKETS AND THE PHENOMENAL SPEED AT WHICH MODERN TRADING SYSTEMS OPERATE ARGUES THAT THE FEDERAL RESERVE NEEDS AT THE VERY LEAST TO MAINTAIN ITS INVOLVEMENT IN ORDER TO LIVE UP TO OUR OBLIGATIONS TO THE FINANCIAL COMMUNITY Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 41 AND TO THE COUNTRY. WE NEED TO BE ABLE TO COUNT ON THE SOUND AND CONTINUED SMOOTH OPERATION OF THE PAYMENTS SYSTEM AND ON OUR ABILITY TO UNWIND PROBLEMS AND CONTINUE TO OPERATE EVEN UNDER SEVERE STRESS. OUR MARGIN FOR ERROR IS CONTINUALLY NARROWING AND CAREFUL MONITORING IS NECESSARY·. 1. I BELIEVE THAT THE FEDERAL RESERVE'S APPROACH BASED ON SUPERVISION AND ON INDUSTRY INPUT, COMBINED WITH OUR STRONG DESIRE TO PROMOTE ECONOMIC EFFICIENCY WILL LEAD TO THE BEST SOLUTIONS. IT HAS BEEN ARGUED THAT SUCH RESPONSIBILITIES ARE INCONSISTENT WITH OUR ROLE IN MONETARY POLICY. PERSONALLY, IN ADDITION TO THE OBVIOUS AND Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 42 I IMPORTANT CONNECTIONS JUST NOTED, I THINK IT'S A GOOD THING TO HAVE A SUPERVISOR WHO CARES ABOUT ECONOMIC As OUTCOMES AS MUCH AS SAFETY. CHAIRMAN GREENSPAN COMMENTED AT THE CHICAGO FED'S BANK STRUCTURE CONFERENCE LAST YEAR, "ZERO BANK FAILURES IS NOT THE OPTIMAL NUMBER" -- THE SYSTEM NEEDS TO PROVIDE FOR RISK AND INNOVATION. THE KEY IS TO STOP THOSE PROBLEMS THAT DEVELOP AT INDIVIDUAL INSTITUTIONS FROM GROWING INTO LARGER SYSTEMIC PROBLEMS. SUPERVISION MUST ALWAYS BE TEMPERED BY THE DESIRE FOR GROWTH, BOTH IN THE FINANCIAL SECTOR AND IN THE ECONOMY AS A WHOLE. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SILAS KEEHN INTERNATIONAL SWAPS & DERIVATIVES ASSOCIATION "REMEMBER -- CENTRAL BANKERS ARE PAID TO WORRY!" MARCH 18, 1994 - PAGE 43 2. WHILE IT IS DIFFICULT TO JUDGE JUST HOW THE LEGISLATIVE PROCESS ON THIS I ISSUE WILL DEVELOP, THINK THE PROPOSAL THAT THE fED HAS PUT I FORWARD IS A GOOD ONE AND HOPE THAT WISDOM AND SOUND JUDGEMENT WILL PREVAIL. THANK YOU. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Silas Keehn (1994, March 17). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19940318_silas_keehn

@misc{wtfs_regional_speeche_19940318_silas_keehn,
  author = {Silas Keehn},
  title = {Regional President Speech},
  year = {1994},
  month = {Mar},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19940318_silas_keehn},
  note = {Retrieved via When the Fed Speaks corpus}
}