[Congressional Record Volume 144, Number 136 (Friday, October 2, 1998)]
[Extensions of Remarks]
[Page E1894]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




                           HEDGE FUND BAILOUT

                                 ______
                                 

                             HON. RON PAUL

                                of texas

                    in the house of representatives

                        Friday, October 2, 1998

  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. 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. 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.
       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.
       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.
       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.
       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. 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.

     

                          ____________________