The truly toxic credit default swaps are “instruments of destruction” that should be outlawed as the world looks to fix and re-regulate the global financial system, billionaire investor George Soros told a banking conference in Beijing on Friday.
Citing GM’s bankruptcy Mr. Soros noted the fact that some bondholders had stood to gain more from bankruptcy than reorganisation as a result of their CDS positions.
From Telegraph:“It’s like buying life insurance on someone else’s life and owning a license to kill him,” he said of the swaps, which pay the buyer face value if a borrower defaults, in exchange for the underlying securities or the cash equivalent.
Mr Soros proposed three principles that should guide regulators as they seek to build systems that will prevent a repetition of events.
Firstly, regulators must overcome their previous tendencies to what Mr Soros called ‘market fundamentalism’ and take responsibility for identifying and correcting asset, credit and equity bubbles before they caused undue damage.
Secondly Mr Soros argued for flexible credit controls that would react to market mood-swings, requiring, for example, mortgage lenders to adjust loan-to-value ratios on residential mortgages in order to forestall property bubbles.
Mr Soros cited the 2001 dotcom equities bubble as an example of where, in his vision for a re-regulated global financial system, regulators would have stepped in to cool the market by freezing new share issues.
Lastly Mr Soros said that the practice of securitizing bank assets had greatly added to systemic risk and must now come under tighter controls, including requiring banks to limit proprietary trading to their own assets in order to protect depositors.
“Banks must use less leveraging and accept risk on their investments, they should not be allowed to speculate on their own account with other people’s money,” he added.
“This may push proprietary trading out of banks and into hedge funds which is probably where they belong.”
Soros’ criticism echoes Warren Buffet’s description of derivatives several years ago as “financial weapons of mass destruction”.
On derivatives in general, Soros believes they should be as strictly regulated as stocks.