Financial Innovation Update

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FINANCIAL INNOVATION UPDATE….Yesterday I passed along Dani Rodrik’s question about whether financial innovation has actually benefited the real economy. As he pointed out, it made homes available to a lot more people, but that turned out not to be such a great thing after all. Reader Brian J. then pointed me to Ben Bernanke’s take on this issue from last year:

The increasing sophistication and depth of financial markets promote economic growth by allocating capital where it can be most productive. And the dispersion of risk more broadly across the financial system has, thus far, increased the resilience of the system and the economy to shocks.

Nope, neither of those turned out to be the case either. I’m tempted to say three strikes and you’re out, but for now let’s keep it an open question.

By the way, yesterday Tyler Cowen recommended this 2006 paper on credit derivatives, so I read it last night. It was quite good, and very accessible to lay readers. I was pleased to see that the authors basically concluded that CDOs are little more than a scam that violates basic economic principles and can only work (for a short time) thanks to industrial size helpings of hooey and sales malarkey. That’s been pretty much my conclusion too. Credit default swaps are a different story, but the problem there is that, perhaps, hedging of risk might not really be such a good idea after all if it turns into an economy-wide phenomenon. After all, the people making/taking a loan (or issuing/buying a bond etc.) are the ones who are in the best position to assess the risk of the loan/bond/whatever and monitor its performance. Selling off risk to someone else often has real benefits, but it also produces incentives not to bother assessing risk properly and creates serious problems of nontransparency.

Also, it can cause the global economy to collapse via cascading counterparty defaults that send us back to the stone age. But that’s a story for another time.

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is the first thing despots go after. An unwavering commitment to it is probably what draws you to Mother Jones' journalism. And as we're seeing in the US and the world around, authoritarians seek to poison the discourse and the way we relate to each other because they can't stand people coming together around a shared sense of the truth—it's a huge threat to them.

Which is also a pretty great way to describe Mother Jones' mission: People coming together around the truth to hold power accountable.

And right now, we need to raise about $400,000 from our online readers over the next two months to hit our annual goal and make good on that mission. Read more about the information war we find ourselves in and how people-powered, independent reporting can and must rise to the challenge—and please support our team's truth-telling journalism with a donation if you can right now.

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