HON. RON PAUL
OF TEXAS
IN THE HOUSE OF REPRESENTATIVES
Friday, October 2, 1998
1998 Ron Paul 105:1
Mr. PAUL.
Mr. Speaker, the Federal Reserve
orchestrated bailout of the hedge fund
Long-Term Capital Management LP raises serious
policy questions. At one point, the notional
value of the Cayman Island-registered
fund’s derivatives totalled about $1.2 trillion.
1998 Ron Paul 105:2
We should look seriously at this issue because
of the taxpayer-backed liability concerns
raised by the involvement of an agency with
the full faith and credit of the U.S. government.
1998 Ron Paul 105:3
The state of Michigan has taken a constructive
first step regarding the public policy
concerns of derivatives. I urge us to consider
the wisdom of the State Representative Greg
Kaza as we debate this issue.
STATEMENT OF HON. GREG KAZA, MICHIGAN
STATE REPRESENTATIVE, ADJUNCT PROFESSOR
OF FINANCE, WALSH COLLEGE
Derivatives are financial instruments
broadly defined as any contract or convertible
security that changes in value in concert
with a related or underlying security,
fixed-income instrument, future or other instrument,
currency or index; or that obtains
much of its value from price movements in a
related or underlying instrument; or an option,
swap, warrant, or debt instrument with
one or more options embedded in or attached
to it, the value of which contract or security
is determined in whole or in part by the
price of one or more underlying instruments
or markets.
1998 Ron Paul 105:5
Although derivatives are a relatively recent
development in financial markets, their
use by corporations, pension and mutual
funds, financial institutions, governments
and those involved in money management
are clearly ascendant, according to the Federal
Reserve and other federal agencies. The
issue is not whether the government should
ban or in some way restrict the prudent use
of derivatives to hedge risk. Rather, the
issue is one of disclosure, i.e., how best to
provide increased transparency as our complex
international financial system enters
the 21st Century.
1998 Ron Paul 105:6
Three years ago I addressed the very same
issue in Michigan by authoring state legislation
that provided increased transparency by
requiring units of government to disclose
their derivative holdings to the public. Government
units have to make investment decisions
regarding the money they receive or
retain; unfortunately, investment practices
and decisions can sometimes lead to significant
losses when taxdollars are unwisely invested
in derivatives. Orange County in California
and Independence Township in Oakland
County, Michigan are both examples of
government units that experienced significant
losses as a result of the imprudent use
of derivatives.
1998 Ron Paul 105:7
Initially, some of my colleagues wondered
whether a ban or restriction on the use of derivatives
would be preferable. But committee
testimony soon convinced them that derivatives,
although complex, are used by many
institutions, including government pension
funds, to prudently hedge risk. Our five-bill
package required public disclosure of derivative
holdings by government units. The legislation
garnered bi-partisan sponsorship and
support, and ultimately became state law.
1998 Ron Paul 105:8
A related issue that we discussed privately
at the time was whether the potential for
moral hazard created by federal deposit insurance
means private financial institutions
should be required to disclose their derivative
holdings in the interest of transparency.
1998 Ron Paul 105:9
You are now likely to contemplate this issue
yourselves given events surrounding the
hedge fund in question, Long-Term Capital
Management; and the potential for systemic
risk posed by any future episode that might
involve the imprudent use of derivatives and
excessive amounts of leverage.
Notes:
1998 Ron Paul Chapter 105
This statement, which was inserted into the Congressional Record’s Extensions of Remarks section and not spoken on the House floor, continues a theme
discussed in
1998 Ron Paul Chapter 102
and 1998 Ron Paul Chapter 104.
1998 Ron Paul 105:1 totalled would be correct in British English, but in American Standard English would be totaled.
1998 Ron Paul 105:4 taxdollars as appearing in the Congressional Record, would make more sense as two words: tax dollars.
