The shortest, best case for financial innovation


Is "financial innovation" some kind of euphemism for more regulation? If not, I thought that's what got us in trouble in the first place.

Cars cause crashes; do we ban cars? Opportunistic dismissals are cheap.

It seems to me there is a "middle ground" approach that is not receiving much attention: create two financial sectors, one of which is heavily regulated and the other not.

My thinking is as follows. The govt felt compelled to bail out a reckless financial industry because its collapse would have devastated the economy, which relies on sound banks to provide short-term credit, student/home loans, and hold savings deposits. Why not create a classification of financial institutions in which institutions providing these "vanilla" services are subject to strict regulation, effectively isolating them from risks borne by other financial institutions.

My thinking is, it wouldn't really be a big deal if Lehman or Goldman failed, if this would not immediately take with it BofA, Citi, etc. (Of course it would be a big deal in the sense that people would lose their investments, but that seems an inevitable, and appropriate, consequence of risk-taking and bubbles, the first of which is argued to be good, the second of which is argued to be inevitable -- the point is to keep the consequences of risk-taking isolated to those who volunteer to take the risks, and giving others the reasonable opportunity to avoid taking those risks.) Thus we could let such firms "innovate" -- and as tools became well understood they could even perhaps be incorporated into the "vanilla" banking sector.

What we have now might not suck so badly if we got rid of a number of recent financial innovations, or regulated them properly. It seems as if every new financial innovation creates new sorts of crises or results in a large number of chumps being taken for a ride. Or both. Small wonder, since there is such a huge incentive to shift risk or con people out of their money until people get wise.

I was thinking the other day about that boring rigid banking system of the 50s and 60s.

It was terrible - you needed a loan, you went to the bank with 20% down on a house and you ended up with a 30 year fixed 5-6% mortgage after a few weeks of bankers checking to make sure you were what you claimed. Or you went to the bank and showed you had a job and could afford to repay the fixed rate loan for a car or personal loan.

It was also terrible that if you had money you picked a bank and they might give you a toaster to open a saving account which would pay 4.5%, 5% if an S&L. If you wanted to write a check, you paid 10 cents for each check, and never wrote a chack that you couldn't cover because you carefully figured out how much was in your checking.

Today we have the innovation of mortgage terms you don't understand that charge 11, 13, 17%. Personal loans are quick and easy and cost 587%, but must be paid back in two weeks.

And if you have cash, well, a bank will charge you $5 a month to hold it for you, and if you are a good customer, might pay you 1%. If you are lucky they won't charge you to open a checking account, but they will definitely charge you to take your money out.

Innovatio is really great because today is much better than the 50s and 60s, if you are a banker. As a consumer, I'd rather have stale old fashion banking.

Somehow I doubt that SW was thinking innovation was the solution.

"Cars cause crashes; do we ban cars? Opportunistic dismissals are cheap."

No but you don't get rid of stop lights and people need to use their blinkers and make sure their brake lights work. And we need police officers enforcing the rules.

No surprise, this is also the shortest, best case for health care reform.

What John Shafer said.

Also, I don't know what "financial innovation" even means in this context. Wasn't "what we have now" (= mortgage meltdown etc.) driven (in large part) by financial innovation?

“I don’t necessarily agree in this particular case, but I don’t think it holds in principle. In fact, I think restrictions on leverage for limited liability firms are a better approach to take.†

there is no right number to limit their leverage by. i’d rather adjust firms ability to limit their liability. and further cut off money supply injections and explicit and implied guratnees to prevent enabling such dangerous leverage.

in general though i see no reason firms shouldnt be able to take a lot of risk, assuming there is no fraud. the problem with our system is most of the risk taken is fraudulent. people keep balances at the bank, and a hold a receipt for cash at par, but the bank doesnt have cash, they have a cdo cubed. an individuals money cant be held in a cash balance AND invested in a cdo cubed simultaneously. this is just stupid accounting and most often is fraudulent at heart.

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