Financial engineering is alive and well with the existence of credit default swaps, according to a US fund manager.
"In my mind the single most disastrous thing that is out there that is unregulated today are credit default swaps," Marvin & Palmer Associates chairman Dave Marvin told members of the Association of Superannuation Funds of Australia (ASFA) yesterday.
"I swear to God that they should outlaw them all over the world, but they haven't and in my mind they are the most easily manipulated things and they are absolutely a nuclear disaster waiting to happen," he said.
"But the authorities aren't doing anything about it because there is a number of the investment banks, dealers, who make money in terms of their spreads and they want to continue to be able to make money," he said.
Credit default swaps work as a form of insurance, where the buyer of the swap transfers the risk of default of a fixed income security to the seller of the swap.
Marvin argued that the regulators in the US should step up their oversight and abolish these types of products as they allow room for financial engineering.
Although Marvin said the global financial crisis was the result of a natural economic cycle in which people move from being prudent to overextending themselves, he argued that the US regulators, including the Securities and Exchange Commission and the Commodity Futures Trading Commission, have been too lenient towards the markets in recent years.
"I think what they did is let all hell break lose and they essentially listened to the efficient market theorists, the hedge funds and the bond people, who said that it would be a nicer world if there weren't regulations. But now you see what happens when there aren't," Marvin said.
Marvin served for 10 years as vice president of the DuPont Pension Fund and was in charge of the managing the US$10 billion portfolio.
