TOP HEDGE fund managers yesterday defended themselves against charges they had contributed to the economic crisis and warned that excessive regulation would "stifle the best innovative qualities" of the financial markets.

In sworn testimony, five of the highest-paid and most powerful hedge fund managers, including George Soros, blamed the crisis on the "financial system itself" as they sought to explain their compensation policies to a committee of sceptical US legislators.

James Simons, president of Renaissance Technologies, said credit ratings agencies had facilitated the sale of "sows' ears as silk purses" because of their "fanciful" ratings of mortgage-backed securities.

Accepting that more robust oversight of their industry was inevitable, they also voiced support for some greater reporting requirements.

Henry Waxman, the California congressman who chairs the US Congress's oversight committee, which is hosting a series of meetings to examine the causes of the financial collapse, said hedge funds' rapid growth and high leverage were factors that had caused other companies to blow up.

Mr Waxman stopped short of blaming the funds - or their trading practices - for contributing directly to the crisis. But he signalled concern over "special tax breaks" that allow managers to treat the vast majority of their earnings as capital gains, meaning some portions are taxed at a rate as low as 15 per cent.

"That's a lower tax rate than many schoolteachers, firefighters or even plumbers pay," Mr Waxman said.

Justifying his own pay package, Philip Falcone, co-founder of Harbinger Capital, pointed to his modest upbringing in Minnesota, where, he said, his father never earned more than $14,000 a year.

"It is important for the committee and the public to know that not everyone who runs a hedge fund was born on Fifth Avenue - that is the beauty of America," he said. He added: "This is not a case where management takes huge bonuses or stock options while the company is failing."

John Paulson, of Paulson Co, whose bearish views on the mortgage bubble made him the most highly paid fund manager last year, according to some calculations, said his pay reflected returns to investors.

Congressman Tom Davis of Virginia said that it was time to consider "greater standardisation, registration, disclosure and regulatory limitations" for the industry.

Kenneth Griffin, the founder and chief executive of Citadel, did not believe greater regulation was required, and said the greatest failures had occurred in regulated institutions. "We have not seen hedge funds as a focal point of carnage," he added.