Drinking the “Financial Innovation” Kool-Aid?

You can smell it on their breath – the tell-tale fumes of “financial innovation.”

Drink it and you start to believe that financial innovation actually exists. The commissioners and their witnesses are being ever so careful to insist that our economy will make room for it, not discourage it, not to over-regulate it , and to find market forces to enhance it.

But they seem incapable of the healthy skepticism expressed so well by Paul Volcker:

"I hear about these wonderful innovations in the financial markets and they sure as hell need a lot of innovation. I can tell you of two - Credit Default Swaps and CDOs - which took us right to the brink of disaster: were they wonderful innovations that we want to create more of? .... I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information.... The most important financial innovation that I have seen in the past 20 years is the automatic teller machine... How many other innovations can you tell me of that have been as important to the individual?" ("What Has Financial Innovation Done for You?" [1])

Here’s a line of questioning they might want to consider:

Which of the financial innovations that have taken place over the past twenty years have been good for the American people? Can you name any at all?

Why not set up a process by which new financial products must be approved (like drugs) before they can poison the economy?

How many of these “innovations” actually are nothing more than sophisticated casino games for those with excess wealth and for those who profit by creating them?

I not looking to slam the commission. But financial innovation is not like any other kind of innovation in our economy. If you create a new IPod and it goes sour, it hurts Apple, its investors and its suppliers. You create a synthetic collateralized debt obligation that goes south, you crash the world economy and kill millions of jobs.

Market forces will never solve the problem of innovation. It will take the heavy hand of regulation or we’ll be bailing out the financial sector again and again when these “innovations” blow up. Warren Buffet is right: to call them “weapons of financial mass destruction.”

We could use some straight talk about how to take them out.

Les Leopold is the author of The Looting of America: How Wall Street's Game of Fantasy Finance destroyed our Jobs, Pensions and Prosperity, and What We Can Do About It [2] Chelsea Green Publishing, June 2009.