03/18/2010 05:12 am ET Updated May 25, 2011

What Has Financial Innovation Ever Done for You?

What does the financial industry have against the regulatory reform? Well, there's money, naturally. The bill that passed the House last week would create a Consumer Financial Protection Agency, a big new watchdog bureaucracy that will inevitably raise compliance headaches and interfere with the industry's unfettered ability to dream up ever more complicated financial products. The way the industry has chosen to phrase this latter concern is to say that reform will hurt consumers by stifling financial innovation.

In this issue of Democracy, economists Simon Johnson and James Kwak skewer the idea that financial innovation is an unqualified blessing for you and me. Former Fed chairman Paul Volcker's rant to bankers in London last week makes the same point.

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.

A few years ago I happened to be at a conference of business people, not financial people, and I was making a presentation. The conference was being addressed by a very vigorous young investment banker from London who was explaining to all these older executives how their companies would be dust if they did not realize the joys of financial innovation and financial engineering, and that they had better get with it.

I was listening to this and I found myself sitting next to one of the inventors of financial engineering who I did not know, but I knew who he was and that he had won a Nobel Prize, and I nudged him and asked what all the financial engineering does for the economy and what it does for productivity. Much to my surprise he leaned over and whispered in my ear that it does nothing. I asked him what it did do and he said that it moves around the rents in the financial system and besides that it was a lot of intellectual fun.
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?

To give financial innovators, their due, I can think of a couple other innovations of the past three decades, besides the ATM, that could fairly be said to have made financial life better:

That's about it, though. Eight useful innovations. Not much to show for 30 years of financial creativity.

Most financial innovations for consumers tend to be ways to fatten profits for financial service providers by rendering simple products more complicated. (I'd join my colleague Allan Roth in putting many life insurance investments in that category.) Too often financial innovations arise not to help people, but to cater to their worst excesses of greed or fear: Technology funds introduced at the height of the tech stock bubble, or the emerging markets funds that inevitably come out of the woodwork at market peaks. In the current risk-averse climate, I'd say that equity-indexed annuities that prey on people's worries about the stock market are another innovation we could live without.

But maybe I'm being too harsh on our financial engineers. Are there others I'm not thinking of that actually have made your financial life better? Are there others you'd single out as especially dangerous?

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