Fed's Bernanke: Swaps market needs improvement

By Joanne Morrison

ARLINGTON, Va (Reuters) - The $62 trillion credit default swaps markets and other off-exchange financial instruments are not managed as well as they should be, Federal Reserve Chairman Ben Bernanke said on Tuesday.

"The infrastructure for managing these derivatives still is not as efficient or reliable as that for more mature markets, as was evident last summer, when a surge in CDS trading volume greatly increased backlogs of unconfirmed trades," Bernanke said in remarks to a mortgage lending forum sponsored by the Federal Deposit Insurance Corp.

Bernanke's comments come as CDS dealers work on a number of systems to reduce credit risk, diminish backlogs and improve processing for these highly complex markets that are mostly unregulated.

The issue was heightened with the near-collapse of Bear Stearns earlier this year, as regulators and market participants feared the firm's CDS exposure was broad-based and would cause systemic risks in the market.

"The potential vulnerability of the financial system to the collapse of Bear Stearns was exacerbated by weaknesses in the infrastructure of financial markets," Bernanke said.

"Bear Stearns' counterparties on thousands of over-the-counter derivatives contracts would likely have had serious difficulty promptly determining their vulnerability to counterparty losses," he added.

CDS MARKET BALLOONS

The complex and privately negotiated credit default swaps market has ballooned over the past decade to more than double the value of the U.S. stock market. These customized transactions in this opaque market are used by companies as an insurance policy to cover losses to banks and bondholders when companies fail to pay their debts.