Wall Street & Markets

Financial innovation (What is it good for?)

By Justin Fox | July 20, 2009 | +

Tyler Cowen writes, in response to a Felix Salmon dismissal of financial innovation as “net, net … a bad thing,”

I can understand that particular financial innovations might be bad, but financial innovation overall?  Surely this claim was false in years 1200, 1900, and also 1950.  (Of course you’ll find very harmful financial explosions between those years and the current day but still on net you’ll take the progress.)

I’m with Tyler in that I’d rather have today’s financial system, however flawed it is, than the financial system of 1200. But at the same time, an estimated 97.3% of all financial innovations (I just made that up, but it seems about right) are just new ways to fleece customers or hide risk, and all major financial crises have been associated with some financial innovation or another. So is there any way to still get the long-run evolution of the financial system that is on balance a good thing, while avoiding the blowups and wealth transfers to financial system players from the rest of us?

The answer may be no. But it seems like some sort of slowing and testing mechanism—akin to the FDA approval process for drugs—could bring more stability while still allowing for innovation. And that’s what the Consumer Financial Protection Agency would be, right?

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  • rwgood

    Instead of estimating 97.3% because it feels right, it makes sense to actually study the problem in that light. I mean, portfolio insurance may have been a major cause of the ’87 crash and it might have disappeared as it was then conducted but there is no doubt that the survivors learned alot about how to operate in various markets in ways that – maybe – couldn’t have been achieved otherwise. My estimate is 79.3%..:) It seems to me that the best way to prevent customer fleecing is more competition and things like the FDA whatever else they do entrench the big players and reduce competition.

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    [...] much financial innovation is desirable?  (Baseline Scenario, Curious Capitalist, Felix [...]

  • http://thefastertimes.com/economicscene/2009/07/20/schiller-vs-consumer-protection-agency/ Schiller vs. Consumer Protection Agency | Economic Scene

    [...] blog world has been piling on to Robert Schiller’s op-ed yesterday in the New York Times, in which he argued in favor of [...]

  • donthelibertariandemocrat

    I’m pretty sure that we’ve proven that Complexity is a bad thing. I’d be much more sanguine about future innovation if we had Narrow Banking as a foundation for our financial system. Of course, that’s an old and out of date idea. We’ve just proven that, haven’t we?

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