Billionaire George Soros, one of the smartest investors ever, today made headlines again when he called for credit default swaps to be outlawed.
"Some derivatives ought not to be allowed to be traded at all. I have in mind credit default swaps. The more I've heard about them, the more I've realized they're truly toxic," Reuters quotes the Hungarian-born businessman as telling an international banking conference in Beijing.
The U.K.'s Telegraph noted that Soros argued for a new regulatory system for global finance that would require regulators to intervene to prevent credit and asset bubbles like the ones that precipitated last year's banking crisis. Regulators, Soros added, must identify credit and other sorts of bubbles before they do significant damage. They also need to take a flexible approach, knowing that they are going to have to make changes as their approaches will prove wrong from time to time.
"Banks must use less leveraging and accept risk on their investments, they should not be allowed to speculate on heir own account with other people's money," the Telegraph quotes Soros as saying. "This may push proprietary trading out of banks and into hedge funds which is probably where they belong."
Credit default swaps, insurance contracts on securities in the event of a default, are widely blamed as one of the causes of the current financial crisis. The unregulated, $70 trillion market became unhinged when the real estate market, particularly houses funded through subprime mortgages, collapsed. American International Group Inc. (AIG), a major seller of CDS securities, needed an $182.5 billion loan from the U.S. government last year to avoid going into bankruptcy.
But the problems with CDSs go beyond the New York-based insurer. As Soros notes, the securities played a role in the recent bankruptcies of General Motors Corp. (GMGMQ), which also required tens of billions in government aid, and AbitibiBowater, North America's largest newsprint producer.
"In both cases, some bondholders owned CDS and they stood to gain more by bankruptcy than by reorganization. "It's like buying life insurance on someone else's life and owning a license to kill," he said.
Soros' comments echo remarks made by Warren Buffett in 2003 when he referred to derivatives as "financial weapons of mass destruction." Soros wants the financial instruments to be as strictly regulated as stocks.
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