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N.Y. Fed: Financial Innovations Threaten Economy MoneyNews
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A key Federal Reserve official says that American investors may be unable to keep up with the fast pace of the U.S. financial system. Timothy F. Geithner, president of the Federal Reserve Bank of New York, says that the growth of new financial instruments such as derivatives could have a ripple effect on the financial markets and the overall economy. Citing the hedge fund collapse of 1998, Geithner told an audience in New York this week that "there are aspects of the latest changes in financial innovation that could increase systemic risk."
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Financial institutions have to work in tandem with government regulators to ensure that both institutional and individual investors manage risk better, he added. "The complexity of many new instruments and the relative immaturity of the various approaches used to measure the risks in those exposures magnify the uncertainty involved," he said. Geithner is particularly concerned about the escalating use of credit derivatives - financial contracts whose value is tied to corporate bonds and loans. "The instruments allow investors to bet on the creditworthiness of a company, while spreading the risk of corporate defaults to the broader market," says The Washington Post, which covered the Geithner speech. "Some analysts worry that a big default or surprising downgrade of debt could trigger cascading losses to hedge funds and the banks, pension funds, insurers, university endowments and other investors that lend money to them." The Post adds that such derivatives usually prosper during good economic times, leading Geithner to remark that credit derivatives "leave us with more uncertainty about how exposures will evolve and markets will function in less favorable circumstances." Geithner is especially concerned with the rising popularity of hedge funds - particularly since they are largely unregulated by government. "A large hedge fund failure could potentially cause greater damage to the core of the financial system than might have been the case in the past," Geithner said. He pointed out that the New York Federal Reserve had to wade in and broker an agreement to rescue Long Term Capital Management after it went belly-up in 1998 - and in the process, the organization rescued the U.S. bond market as it teetered on the brink of collapse after the LTCM credit debacle. "Many analysts have worried that the Fed's success in managing that financial crisis and others that occurred during Alan Greenspan's 18-year tenure as Fed chairman have lulled many investors into underestimating financial risks," says The Post. Editor's Note:
2. Wage Growth Key to Economy, Says Expert While housing's contribution to economic growth is beginning to fade, its impact on the financial markets may be overstated. It all comes down to jobs, says Gary Wolfer, senior portfolio manager at Univest National Bank and Trust Co.'s Wealth Management and Trust Group in Pennsylvania. "The key will be wage growth as hiring throughout the year continues at a strong pace as corporations boost payrolls," Wolfer says, noting that the trend is toward full employment.
"This has an incredibly positive psychological impact on the consumer psyche." Editor's Note:
3. Virgin Islands Officials Want Tax Loophole Back The New York Sun is reporting that the U.S. Virgin Islands will lobby Congress to reopen a tax loophole that, in the past, allowed wealthy Americans to avoid paying up to 90% of their personal federal income taxes. In testimony before the U.S. Senate Energy Committee this week, representatives from the Virgin Islands say that they want the U.S. government to ease residency and income restrictions that were put in place in 2004 - after the media reported that U.S. citizens were hiding income in V.I. by manipulating the American territory's tax law. "Observers familiar with the efforts said the primary target is Senator Crapo, a Republican of Idaho, whom Virgin Islanders hope will introduce an amendment to upcoming tax legislation allowing individuals to be considered USVI residents if they spend just three months out of every year there," says The Sun. The debate will likely focus on the Virgin Island's Economic Development Commission, which was rolled out in 1972 to help the island gain an economic foothold by attracting individuals and businesses to relocate to the region. "The program has been promoted heavily by the Department of the Interior, which has jurisdiction of the USVI and America's other territories, as providing 'profit opportunities unknown to most businesses,' " The Sun reports. "As technology has removed the physical bonds keeping hedge funds and other financial-services firms - and the people who run them - in major financial centers like Chicago and New York, the program has grown in popularity over the last 10 years."
Documented abuses by Americans stashing income on the island forced Congress to insert a provision in the October 2004 American Jobs Creation Act that closed the loophole. The legislation stated that in order to qualify for Virgin Islands residency (and the tax breaks associated with that status) a person would have to spend at least six months in V.I. But The Sun reports that Virgin Islands officials complain that the new restrictions have gone "too far." The Sun quotes Democratic Rep. Donna Christensen, the non-voting USVI delegate to the House, as saying: "We believe Congress went much further than needed in its attempt to deal with abuses in the program, and, as a consequence, has put our entire program, which accounts for 20% of government revenues, at serious risk." Christensen wants the number of residency days to be slashed from 183 to 122 over the next three years. The Sun says that Sen. Crapo is "amenable" to the reduction. His support would virtually guarantee passage of the provision, the paper adds. Editor's Note:
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