Financial innovation

Hi KL,
Robert Shiller wrote a column in the Financial Times (27 Sep 2009) with the above title.

The main thrust is that the source of this crisis lies in imperfect financial architecture, rather than over-complexity of products. We should recognise that increased complexity offers potential rewards as well as risks. Complexity is only problematic when used to obfuscate and deceive. Regulators beginning to actively discourage complexity are headed in wrong direction. Innovation in financial sector has to be upheld to improve our lives, the same as innovation in any other sectors. Thus regulators need to be given a stronger mandate and more qualified manpower to encourage innovation.

The conclusion is to use this crisis to promote innovation-enhancing financial regulation, not to let this be eclipsed by superficially popular issues.

Shiller's arguments appear sound to me. Innovation is the lifeblood of capitalism, driving productivity growth, and should be actively encouraged under proper regulation.

I am thinking perhaps it would help if you state your stand on this, so that people will not read you wrongly, or to quote you out of context. Are you in principle opposed to financial innovation (leading to increased complexity)? Or fundamentally it is the crooked salesforce to blame who exploited the complex products? Or we should point at the regulators? If regulation is perfect, there is no way a seller can cheat, and buyers are informed of all associated risks & rewards, do you think complex products are alright?

In your writings, you have recommended easy-to-understand products to men on the street - low cost with fair distribution of rewards. Your well-meaning intention is very clear, no doubt about this. Less clear is the driving principle: because you think financial innovation is bad, or you think the ethics of banks is very questionable, or you think the regulators will never catch up with the industry players' tricks etc. This is important because the proposed remedy will be different. If innovation is bad, we will ask regulators to ban/minimise creativity; if innovation is helpful but consumers are often poorly informed, we should push for better communication by sellers while retaining innovative drive; if regulators are themselves behind the curve and not equipped with necessary skills, we need to incentivise more talents to join them.

Hope to see a response. Thanks for your time!

YZ

MY REPLY

I am against complex products that are designed to "cheat" the consumers and marketed under the name of "financial innovation". The main culprits are the financial engineers who design these products, although the people who sell these products have to share the blame for being greedy to earn the attractive commission. The regulators also failed in the duty by allowing these products to be sold.

There is a proper place for financial innovation, to keep up with the times and changing needs of society. For example, we have to innovate to provide a better system of financing health care. We need a better system to allow people to pay their mortgage installments in an environment of irregular employment.

It is better for the innovation has to be carried out as a joint effort by the industry, consumers and the regulators.

We will need a consumer protection agency that has the power to safeguard the interest of consumers. This function used to be performed by regulators, but they have neglected this function in recent years under the misguided strategy of "leave it to the market". This role has to be reinstated. America is addressing this issue now.

Tan Kin Lian