A Brief Case for Financial Innovation

Like getting fuel perks at the local gas station?

Like that you can use them while you use a credit card at the pump?

Like that you can lease the car that you drove to the gas station?

Like that cars are actually affordable by average people at all?

Like that you can pay for gas with dollars and not a commodity like chickens or oxen?

All of these are due to financial innovation. Fuel perks are an alternative currency. Credit cards are on-demand credit & electronic processing. Leasing is made possible by liquid capital markets and derivatives & swaps for auto resale & currencies. Global mass manufacturing can only work with complex financing (equity, debt, and combinations thereof), currency derivatives, commodity futures, and host of products that are all financial innovations.

I'm sick of people claiming that the financial industry "doesn't build anything". These, very often smart people, think that innovation is great in nearly every field, but that it's unneeded or even reckless in finance. I was at a meeting of scientists and engineers talking about economics, and they kept asking: "How can we stop financial innovation?!?". It's funny because I imagine what they'd say to: "Can't we stop X by banning research in that area?"

They do have a point in the short term though: often new financial products cause bubbles to form from poorly valued products and those can hurt people in the short term. In the long term though, these products are either discarded or refined. The problem isn't that new financial products are bad; it's that transparency in these financial products is bad. These people should be calling for transparency - not an end to financial innovation.

I think financiers (and no, not just "responsible" ones) should be given the credit for helping to create innovative ways to fund our dreams and cushy lifestyles. I'm not saying that I'm happy with the current oligarchy in the financial sector - far from it. I want increased competition and more innovation.

I don't care if they "don't make anything" directly - they provide the ability to. Ask an entrepreneur whether they'd prefer to have the skill to either raise money or physically "build things" - it's not the latter I assure you. Financing is a universal - every business, non-profit, etc. needs it. If you have money, you can pay the guys to build you something. 

If you don't have money, you need to talk to the finance guys - whether that's your rich uncle, a venture capitalist, or the bank down the street. Until we find another universal means of exchange, we're stuck with needing money to unlock many of our dreams.

Comments

[Colin Dean]

Money isn't required for everything, but it sure as hell makes things a lot easier. Financiers produce something: they produce the funds necessary for others to keep producing; the funds necessary to help others realize their dreams.

Unfortunately, like all industries, some products fail. Unfortunately, the bubble which caused this current recession was a perfect storm of product failure and government over- and under-regulation. Credit liquidity makes life a lot easier for bankers, but when they mess up, it's the people who depend on that liquidity who suffer. Thus our current predicament.

Obama promised transparency. He's working on it, but he could have done a lot more a lot sooner. He could have done so much more day one in office! If he really wants transparency, he'll support Ron Paul's H.R. 1207, the Federal Reserve Transparency Act (http://www.govtrack.us/congress/bill.xpd?bill=h111-1207).

[twitter.com/NickPinkston]

Yea, I'm with you. Money is required for nearly everything, and I also hope that HR 1207 passes. I know it has a lot of support, but I'm still skeptical it will pass or even be implemented.

I think that you're right to point out that bankers' incentives aren't always in line with society at large, however that's always going to be the case. Regulation can never keep up with the market. That's why transparency is needed so that the market can value things better.

There is still the issue of medium term groupthink in markets though, and I'm not sure how we can encourage the contrarian behavior that would right the market - but it seems like that's part of the answer.

[TMR]

I'm glad to hear this-- it needs to be said.

It can also be said, however, that the fact that the very notion of financial technology is being regarded with such superstition and skepticism is a sign that something has gone horribly, horribly wrong in its implementation.

And I think you're quite right, that what has gone wrong is lack of transparency. It's as though we'd said to the meat industry, "oh, it's a trade secret whether you use cows that died of massive bacterial infections? Well I'm sure you know what's best!"

I tend to be a realist about things, and am wary of the way that money can react with politics in ways that just don't happen in other industries, but it's definitely time we took a more nuanced set of tools to the task-- neither those who would worship or hang the bankers are right here.