Felix Salmon at Reuters writes:
Nicola Gennaioli, Andrei Shleifer, and Robert Vishny have a great new paper out entitled "Financial Innovation and Financial Fragility”.* It doesn't break a lot of new conceptual ground, but it's very thought-provoking, and it helps to codify in a formal way the serious problems with financial innovation. Their conclusion is spot-on, I think:
"Recent policy proposals, while desirable in terms of their intent to control leverage and fire sales, do not go nearly far enough. It is not just the leverage, but the scale of financial innovation and of creation of new claims itself, that might require regulatory attention."
The idea here is that financial innovation is, by its nature, inherently and predictably dangerous. If something's innovative, it's new. And if something's new, it's untested. Meanwhile, a very large part of what we consider "financial innovation"consists of "improving" on existing securities, usually by creating a source of new supply for in-demand securities while also providing some kind of pick-up in yield...
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