Timothy Geithner, the 9th president of the Federal Reserve Bank of New York, recently shared his view of the credit derivatives market with The New York Times. The market is currently valued at USD26 trillion.
Geithner has persuaded Wall Street to take a closer look at the issues surrounding credit derivatives, such as the way the system functions, stress-testing, and examining the relationship between hedge funds and banks.
“We’ve seen substantial change in the financial system, with the emergence of a very large universe of leveraged private funds, rapid growth in exposures to more complicated and less liquid financial instruments, all during a period of very low volatility,” says Geithner, in his interview with the New York Times. “This means we know less about market dynamics in conditions of stress. The fact that the banks are stronger and risk is spread more broadly should make the system more stable. We can’t know that with certainty though. We’ll have a test of that when things next threaten to fall apart.”
Geithner and his staff reviewed counterparty risk in 2004 by examining the results of the Counterparty Risk Management Group Report. After doing this he brought together a group who produced a report, making 47 technical and philosophical recommendations.
They found weaknesses in the assignment and trading of credit derivatives. They found that banks were “assigning” the contracts out to others without telling each other. In response to this they decided to collect data from everyone and anonymously distribute it to the group so that every bank could see it.
He also implemented stress-testing examinations which looked at how banks measure and test exposure to market players and market risks. He is currently in the process of working with European regulators examining the relationship between banks and hedge funds.