Derivatives played a strong role in the credit crisis, which was sparked by the meltdown of subprime mortgage securities two years ago.
As a result, much stricter regulation is needed for derivatives, says hedge fund legend George Soros.
“I have strong views on the regulation of derivatives,” he writes in the Financial Times.
“The prevailing opinion is that they ought to be traded on regulated exchanges. That is not enough.”
So what’s needed? “The issuance and trading of derivatives ought to be as strictly regulated as stocks,” Soros says.
“Regulators ought to insist that derivatives be homogenous, standardized and transparent.”
The problem with customized derivatives is that they “only serve to improve the profit margin of the financial engineers designing them,” Soros writes.
“In fact, some derivatives ought not to be traded at all. I have in mind credit default swaps.”
The recent bankruptcies of General Motors and Abitibi Bowater show the damage that CDS can cause, Soros explains.
“In both cases, some bondholders owned CDS and stood to gain more by bankruptcy than by reorganization. It is like buying life insurance on someone else’s life and owning a license to kill him. CDS are instruments of destruction that ought to be outlawed.”
In its new financial regulation plan, the Obama administration wants The Securities and Exchange Commission and Commodity Futures Trading Commission to have "clear, unimpeded authority to police and prevent fraud" in the derivatives market.
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