Financial innovation is hot. Too hot perhaps, as some people think it helped sink the global economy in 2008. But bankers are stumped when it comes to getting government out of housing.
Here's something you'll rarely see cited as a problem: The U.S. has too little financial innovation. The creativity of bankers and traders is one thing that enables them to make so much money. They think up fancy solutions to financial problems. Sometimes these involve complicated new securities designed by a couple of math Ph.Ds and may be well-understood by only a handful of people.
Financial innovation was a big factor in the international credit meltdown in 2008. We thought we had eliminated risk with clever financial instruments. We were wrong.
But today, the U.S. economy suffers from another failure of Wall Street innovation. The U.S. financial industry can't seem to figure out how to limit the government's role in the mortgage market.
Wall Street: The Silicon Valley of Financial Innovation
For starters, it isn't hard to understand why the U.S. has seen so much financial innovation over the past decade: it has paid very, very well. Few jobs out there can offer big six- and seven-figure paychecks to people who are very good at math and don't want to take the risk associated with entrepreneurship. The incentives for financial innovation are clear enough, so it's no wonder that some of the best mathematical minds made their way to Wall Street.
Some prime examples of innovation can be found in the asset-backed securities market. Back when mortgage-backed securities were invented a couple of decades ago, they were a pretty slick idea. They provided banks with more funding for mortgages and investors with bonds structured to their liking. Similar securities were developed for other consumer products like auto loans and credit cards. Even some interesting esoteric asset-backed securities were created, which were backed by weird assets like lottery winning payment streams or periodic lawsuit settlement payments.