Rethink debt obligations: Greenspan

Former Federal Reserve Chairman Alan Greenspan said that there will be "some rethinking" of collateralized debt obligations after 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 collateralized debt obligations (CDO)."

Central banks have raised concern about the way markets assess the risk of CDOs, which are bonds based on underlying debt and other assets.

Bank of England official Andrew Haldane said on September 28 that banks' tests for assessing the impact of financial shocks on CDOs are "completely hopeless".

"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 has been "a net plus to the community" for the new products that have been created, "there is 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.

"A lot of structured products are going to have short life expectancies," Greenspan said.

One in five managers of CDOs is likely to be forced to cut costs or go out of business as investors avoid the securities following losses on subprime debt, Fitch Ratings said September 24.

As many as 40 per cent of managers focused only on asset- or mortgage-backed bonds may be "impaired", Fitch said. Haldane, the UK central bank's head of market infrastructure, called for a "fundamental rethinking of the way we do stress testing", in a speech last week in Chicago.