updated 5/5/2005 11:39:27 AM ET 2005-05-05T15:39:27

Federal Reserve Chairman Alan Greenspan issued a fresh call on Thursday for Congress to limit the multibillion-dollar holdings of the mortgage giants Fannie Mae and Freddie Mac, warning that their huge debt could hurt U.S. financial markets.

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Greenspan's comments came in a speech that focused on the broader issue of the growing use of complex financial instruments, known as derivatives. The Fed chief, as he has done in the past, saw problems with the use of derivatives but also warned against increased government regulation in this area.

Concerns about potential market disruptions posed by the two mortgage giants "will remain valid until the vast leveraged portfolios of mortgage assets held by Fannie and Freddie are reduced and the associated concentrations of market risk and risk-management responsibilities are correspondingly diminished," Greenspan said.

Greenspan's speech was delivered via satellite to a Federal Reserve Bank of Chicago's annual conference on banking. A copy of his remarks was distributed in Washington.

On Capitol Hill, various proposals have been offered to rein in Fannie Mae and Freddie Mac.

Fannie Mae is the No. 1 U.S. buyer of home mortgages, while rival Freddie Mac ranks as second-largest buyer.

Congress created Fannie Mae and Freddie Mac to inject money into the home-loan market. They buy mortgages and bundle them into securities for sale to investors worldwide.

During a question-and-answer period, Greenspan said the two mortgage companies "should hold only the minimum level of assets needed to accomplish the primary missions mandated by their charter."

Shrinking their holdings, he said, could be accomplished "over the course of several years."

He also said limiting the size of Fannie's and Freddie's portfolio holdings probably wouldn't affect mortgage rates for homeowners because so many big banks and other lenders compete with them in the home-loan market.

Federal regulators last year accused Fannie Mae of serious accounting problems. It was ordered to restate earnings back to 2001, a correction that could reach an estimated $11 billion (euro8.5 billion). The accounting fiasco, which involved derivatives, led to the ouster of the company's chief executive and top financial officer.

Freddie Mac had its own accounting debacle in 2003, and three top executives were forced out. It had misstated earnings by $5 billion for 2000-2002.

On the broader issue of derivatives, Greenspan said that banks, hedge funds and other big financial players that use derivatives must always assess whether they are effectively managing their risk.

"The rapid proliferation of derivatives products inevitably means that some will not have been adequately tested by market stress," Greenspan said. Financial players, he said, "must be aware of the risk-management challenges associated with the use of derivatives ... and they must take steps to ensure that those challenges are addressed."

Derivatives essentially are contracts whose value depends on an underlying asset such as the value of a currency or a bushel of wheat. They are used by financial companies to guard against losses from unexpected market movements.

Over-the-counter derivatives traded privately between investors are largely unregulated, in contrast to those derivatives traded on futures exchanges.

The global over-the-counter derivatives market is estimated to have a value of $220 trillion (euro170 trillion), Greenspan said.

In his speech, Greenspan did not address the future course of interest rates or the state of the U.S. economy. The Federal Reserve on Tuesday boosted a key interest rate by one-quarter percentage point to 3 percent. That marked the eighth increase since the Fed began to tighten credit last June.

Copyright 2005 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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