Oct. 2 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said there will be ``some rethinking'' of collateralized debt obligations after demand for them helped fuel a bubble in the U.S. subprime mortgage market.

``People always say it's the subprime market that created this crisis,'' Greenspan told investors at an event hosted by Bloomberg LP in London. ``It's the subprime asset-backed market'' which did, he said. ``As a consequence of that, there's going to be some rethinking about collateralized debt obligations.''

The comments suggest Greenspan is moderating his enthusiasm for derivatives, which he has often praised for diversifying risk. Central banks have raised concern about the way markets value CDOs, securities based on underlying debt and other assets. Losses on them helped curb third-quarter profit at Citigroup Inc., the biggest U.S. bank.

``The Wall Street firms were under real pressure to supply asset-backed securities, and the Wall Street firms were pressing the lenders to give them more raw material,'' Greenspan said today. ``Credit standards just went straight down, and applications for subprime mortgages soared. The consequences of that are evident.''

Citigroup's earnings showed that it lost $1.3 billion on subprime assets, contributing to bigger losses than any others disclosed by the world's top banks and securities firms. UBS AG, Europe's largest bank, said yesterday that it had a loss after writing down about $3.4 billion of securities.

`Aggressive' Products

The derivatives market has expanded to cover almost $403 trillion in assets as of June 30, up from about $70 trillion as of the end of 2001, according to the International Swaps and Derivatives Association, an industry group. The data include contracts that are privately negotiated between banks and investors such as credit-default swaps used to speculate on corporate creditworthiness and contracts used to swap between fixed and floating interest payments.

``Once liquidity comes back and confidence returns more broadly, with any luck we will see a resumption in activity in the market for CDOs,'' said Suki Mann, a credit strategist at Societe Generale in London. ``However, it's highly unlikely that the products will be as aggressive as they once were.''

The market for CDOs is already shrinking. Worldwide issuance of CDOs fell to $17.3 billion in September, about a quarter of the monthly average for the past 12 months, according to data from JPMorgan Chase & Co. CDOs are created by packaging bonds, loans or credit-default swaps and using their income to pay investors interest.

`Net Plus'

``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 must ``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 Sept. 24. As many as 40 percent of managers focused only on asset- or mortgage-backed bonds may be ``impaired,'' Fitch said.

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

Dow Reaches Record

European Central Bank President Jean-Claude Trichet last month called for an examination of how risk management practices at financial institutions and the rapid growth in markets for products such as CDOs fueled recent market turmoil.

Greenspan said that investors are assuming the worst of the credit slump has passed. The Dow Jones Industrial Average yesterday climbed above 14,000 for the second time in its 111- year history to close at a record, recovering from a sell-off in July and August.

``We're seeing signs in the last week or so that a number of areas of significant strain are easing,'' Greenspan said. Still, he cautioned that ``we're not out of the woods yet.''

To contact the reporter on this story: Jennifer Ryan in London at Jryan13@bloomberg.net

Last Updated: October 2, 2007 16:23 EDT