Ross Levine and Joseph Stiglitz debate on merits of financial innovation in this Economist Forum. Overall the broad ideas are the same. Ross Levine who says financial innovation is useful looks at history and says how i-banks came up to finance rail roads in 19 century, how liquid bond market came up in 17 and 18 century to finance oceanic expeditions and how venture capital helped fund biotech and information tech industry.
Stiglitz says finance is useful but not in the current form. It is not an end but a means to an end. Financial services should be done at low cost but has become too expensive. The recent wave of so called financial innovation has actually worsened economic outcomes with benefits flowing to financial firms and losses going to taxpayers.
Overall both say the same point in different ways. But the examples shown by Levine is what finance should be doing and Stiglitz would agree to. It is the current form of financial innovation where the problems are. Infact there is no real innovation here. It is just herding to make profits from whatever possible ways.
Another thing which I don’t understand is Levine comparing finance to other sectors. He says in other sectors also we have problems – information tech eases identity theft, drugs are abused etc. We don’t say stop innovating in them so why should we say the same for finance? Even they have risks. Well said but finance is very different. The amount of damage caused by badly created financial products is far more. Moreover, it affects the people involved in creating these products the least. Just look at the bonuses being distributed by financial sector now. And most of the population still reels under unemployment problems. It is both funny and sad. We still have not managed to understand the issues despite such a big crisis.
Am not saying financial innovation is not useful. But we must understand the implications as well
22/03/2011 at 8:26 pm |
Financial innovation is and can be beneficial. However, Amol points out “Herding” an expression I can agree with completely. But, I must respond a bit perplexed to the statement of no innovation.
From the birth of derivatives in the 80′s to Credit default Swaps markets shortly following, we had massive innovation and growth of what is two of the largest markets on earth. If we follow the evolution of those markets we find that in the end of 2007 it was “Herding” in these two very flawed markets that precipitated the crash along with Governmental and Quasi Governmental structures.
Derivatives were flawed when instead of a design to fit Customer need as originally intended by creating Interest Only (IO) and principal Only strips or “Tranches” Wall ST. continued a bad practice of Re-tranching endlessly to get issuing spreads and fees that became corrupted.
CDS, instead of being placed quickly into a Public Exchange, was maintained as private contracts between two parties, one insured and one insurer. It had no set margin calls or daily cash reconciliation. It was not public so the positions of the wall St and other entities could easily be seen. As seen in AIG and others, the “tremendous Herding” began there as well.
Following this, terrible consequences occurred to the tax payer in the form of debt.
I know some will argue that it was the volatility of consumer debt going bad that was the majority cause of financial loss and not just a preceding spark. That’s a debate I would greatly look forward to pursuing.