Yesterday, Paul Krugman argued in the NY Times that banking should be made boring again. Essentially, he thinks that the best financial reform would create a system that lessens household debt and the incentives for people to develop sophisticated and complex financial instruments that may lead to a recession like the one we're currently experiencing.
Do you believe this will happen? I think that to some extent that it may be a good idea to decrease the risk, but at the same time I don't think the innovation within the financial industry will (or should) be stopped. We discussed micro-financing during the presentation the other day as a relatively new phenomenon which has both its advantages (available credit and relatively good returns) and disadvantages (people increasing their debt even further), but I'm not sure that Krugman would agree that these kind of developments would be beneficial to the society as a whole.
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Interesting post Eric, I would tend to agree with you that financial innovation has it's purpose. Granted there are some very speculative instruments in play right now but many of the "exotic" derivatives actually are used by many companies to hedge risk and reduce volatility. The decrease in market volatility associated with eliminating these derivatives may be counter-acted by an increase in earnings volatility by many large companies, thereby increasing market volatility.
ReplyDeleteTechnology has given computational power exceeding the power of the human mind to comprehend. Instead of taking the approach of limiting financial products, perhaps financial and business leaders can adhere to the advice they give their own children and NOT BUY THINGS THEY DONT UNDERSTAND.
Hmmm... Interesting comment, Joel. I disagree that the computational power exceeds the power of the human mind to comprehend. While calculations can be made by computers that may not be able to be done by humans, the underlying logic of the programs can and must be understood by humans. People are the ones generating the logic to create the programs. On the other hand, the masses may not understand complex financial products. Perhaps, then this is an issue of education. I believe there is a trend toward incorporating more elements of personal finance into the public school system.
ReplyDeletehttp://www.moneyinstructor.com/art/ninthtenthgrademoney.asp
Even with basics like credit cards, college students manage to make poor financial decisions and incur lots of debt.
http://www.bankrate.com/brm/news/cc/19980605.asp