LONDON: Former Federal Reserve chairman Alan Greenspan said there will be “some rethinking'' of collateralised debt obligations after demand for them helped fuel the collapse of the US subprime mortgage market.
“People always say it's the subprime market that created this crisis. It's the subprime asset-backed market'' which did, Greenspan told investors in a discussion at Bloomberg LP in London. “As a consequence of that there's going to be some rethinking about collateralised debt obligations.''
Central banks have raised concerns about the way markets assess the risk of CDOs, which are bonds based on underlying debt and other assets.
Citigroup Inc, the biggest US bank, said yesterday credit and trading losses on loans and mortgage-backed securities led to a 60% drop in its third-quarter profit.
“The Wall Street firms were under real pressure to supply asset-backed securities and the Wall Street firms were pressing the lenders to give them more raw material,'' Greenspan said yesterday. “Credit standards just went straight down, and applications for subprime mortgages soared. The consequences of that are evident.''
Citigroup earnings showed it lost US$1.3bil on subprime assets.
The market for CDOs is already shrinking. Sales fell 54% in August to US$17bil from July, the lowest in more than a year, according to Morgan Stanley.
CDOs are created by packaging bonds, loans or credit-default swaps and using their income to pay investors interest.
“The pricing which in too many cases has been, by some model derivation, four times removed from actual market prices, just doesn't work,'' Greenspan said. Still, CDOs “serve a useful purpose''.
While financial innovation had been “a net plus to the community'' for the new products that had been created, “there has got to be a limit as to how many you can create, and we're way past that limit as far as I am concerned,'' he said. – Bloomberg