《《Special report-Financial innovation》.docxVIP

Special report:  HYPERLINK /specialreports?year%5bvalue%5d%5byear%5d=2012category=76984 Financial innovation Playing with fire Financial innovation can do a lot of good, says Andrew Palmer. It is its tendency to excess that must be curbed Feb 25th 2012 | from the print edition  HYPERLINK /share Tweet FINANCIAL INNOVATION HAS a dreadful image these days. Paul Volcker, a former chairman of America’s Federal Reserve, who emerged from the 2007-08 financial crisis with his reputation intact, once said that none of the financial inventions of the past 25 years matches up to the ATM. Paul Krugman, a Nobel prize-winning economist-cum-polemicist, has written that it is hard to think of any big recent financial breakthroughs that have aided society. Joseph Stiglitz, another Nobel laureate, argued in a 2010 online debate hosted by The Economist that most innovation in the run-up to the crisis “was not directed at enhancing the ability of the financial sector to perform its social functions”. Most of these critics have market-based innovation in their sights. There is an enormous amount of innovation going on in other areas, such as retail payments, that has the potential to change the way people carry and spend money. But the debate—and hence this special report—focuses mainly on wholesale products and techniques, both because they are less obviously useful than retail innovations and because they were more heavily implicated in the financial crisis: think of those evil credit-default swaps (CDSs), collateralised-debt obligations (CDOs) and so on. This debate sometimes revolves around a simple question: is financial innovation good or bad? But quantifying the benefits of innovation is almost impossible. And like most things, it depends. Are credit cards bad? Or mortgages? Is finance as a whole? It is true that some instruments—for example, highly leveraged ones—are inherently more dangerous than others. But even innovations that are directed to unimpeachably “good” ends