alan greenspan : technology and financial services remarks by mr alan greenspan, chairman of the board of governors of the us federal reserve system, before the journal of financial services research and the american enterprise institute conference, in honor of anna schwartz, washington, on 14 april 2000. * * * i am pleased to participate in today ’ s conference and to join others in the justly deserved tributes to anna schwartz. she has been most interested, among a wide variety of other subjects, in the connections that economic and financial policies have to financial crises. as a consequence, i have decided to speak about technology and financial services, and particularly about risk management, issues that i have spent a good deal of time addressing in recent years. as a related matter, i will comment on supervision and regulation as we move into the 21st century, and of course, i shall find a way to touch on the role of central banks. without doubt, the acceleration in technology that has produced such an extraordinary effect upon our economy in general has had a particularly profound impact in expanding the scope and utility of financial products over the last fifteen years. information technology has made possible the creation, valuation, and exchange of complex financial products on a global basis heretofore envisioned only in our textbooks, and even that just in recent years. derivatives are obviously the most evident of the many products that technology has inspired. but the substantial increase in our calculation capabilities has permitted the putting into place of a variety of other products and, most beneficially, new ways to unbundle risk. what is really quite extraordinary is that there is no sign that this process of acceleration in financial technology is approaching an end. we are moving at an exceptionally rapid pace, fueled not only by the enhanced mathematical applications produced by our ever - rising computing capabilities but also by our expanding telecommunications capabilities and the associated substantial broadening of our markets. all the new financial products that have been created in recent years contribute economic value by unbundling risks and reallocating them in a highly calibrated manner. the rising share of finance in the business output of the united states and other countries is a measure of the economic value added by the ability of these new instruments and techniques to enhance the process of wealth creation. the reason, of course, is that information is critical to the evaluation of risk. the less that is known about the current state of a market or a venture, the less the ability to project future outcomes and, hence, the more those potential

outcomes will be discounted. financial intermediation, although it cannot alter the underlying risk in holding direct claims on real assets, can redistribute risks in a manner that alters behavior. this redistribution of risk induces more investment in real assets, presumably engendering a higher standard of living. this occurs because financial intermediation facilitates diversification of risk and its redistribution among people with different attitudes toward risk. any mechanism that shifts risk from those who choose to withdraw from it to those more willing to take it on increases investment without significantly raising the perceived degree of discomfort from risk borne by the public. by itself, more abundant real - time information should both reduce the uncertainties and lower the variances employed to guide portfolio decisions. at least part of the observed fall in equity premiums in our economy and others over the past five years may have resulted from a permanent technology - driven increase in information availability, which by definition reduces uncertainty and therefore risk premiums. and because knowledge once gained is irreversible, so too are the lowered risk premiums. but while financial intermediation, through its impetus to diversification, can lower the risks of holding claims on real assets, it cannot alter the more deep - seated uncertainties inherent in the human evaluation process. there is little in our historical annals that suggests that human nature has changed much over the generations. but, as i have noted previously, while time preference may appear to be relatively stable over history, perceptions of risk and uncertainty, which couple with time preference to create discount factors, obviously vary widely, as does liquidity preference, itself a function of uncertainty. these uncertainties are an underlying source of risk that are too often regarded as background noise and are generally not captured in our risk models. i have previously called attention to changing risk perceptions as a risk - management challenge in a different context when discussing the roots of the recent international financial crises. my focus has been on the perils of risk management when periodic crises - characterized by sharply rising risk premiums - undermine risk - management structures that fail to address them. during a financial crisis, risk aversion rises dramatically, and deliberate trading strategies are replaced by rising fear - induced disengagement from market activity. it is the general human experience that when confronted with uncertainty, whether in financial markets or in any other aspect of life, disengagement is the normal protective reaction. in markets that are net long, the most general case, disenga