Air Of Sophistication

SARBANES: Warren Buffett has warned us that derivatives are time bombs, both for the parties that deal in them and the economic system. The Financial Times has said so far, there has been no explosion, but the risks of this fast growing market remain real. How do you respond to these concerns?

BERNANKE: I am more sanguine about derivatives than the position you have just suggested. I think, generally speaking, they are very valuable. They provide methods by which risks can be shared, sliced, and diced, and given to those most willing to bear them. They add, I believe, to the flexibility of the financial system in many different ways. With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly. The Federal Reserve's responsibility is to make sure that the institutions it regulates have good systems and good procedures for ensuring that their derivatives portfolios are well managed and do not create excessive risk in their institutions.

-Senate Banking Committee hearing to confirm Ben Bernanke as Alan Greenspan's successor, November 2005


[T]he increasing prominence of hedge funds and the growth of the market for credit derivatives are both aspects of the remarkable wave of financial innovation that we have seen in recent years. Both of these developments have also been the subject of public policy debates, including calls for increased regulation. ... The increasing sophistication and depth of financial markets promote economic growth by allocating capital where it can be most productive. ...
[M]arket discipline can be an important element in a well-functioning regulatory scheme. ... Some complex instruments can be valued only with the aid of sophisticated modeling techniques. The problems of valuation and of risk measurement faced by investors in tranches of bespoke collateralized debt obligations (CDOs) are a good example.

-Ben Bernanke, May 15, 2007, less than four months after the below email was sent.


"More and more leverage in the system, The whole building is about to collapse anytime now...Only potential survivor, the fabulous Fab[rice Tourre]...standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!"

-Email in January 2007 from Fabrice Tourre, the Goldman Sachs executive charged last week with derivatives/CDO-related fraud, from page 7 of the SEC complaint.