Innovation contributes to future financial crises.
Kwak 2012 [James Kwak, Simon Johnson; AB in social studies from Harvard College and Ph.D. in history from the University of California, Berkeley, JD at Yale Law School; Simon Johnson, a former chief economist at the International Monetary Fund, is a professor at the MIT Sloan School of Management, Faculty Director of MIT’s Shaping the Future of Work initiative, and Co-Chair of the CFA Institute Systemic Risk Council. “Is Financial Innovation Good for the Economy?” 2012. The National Bureau of Economic Research.
. Accessed 6/25/24.] LT
There has been a great deal of financial innovation in recent decades but its social value is unclear. In the run-up to 2008, banks took large amounts of risk relative to the size of the economy. This approach was made possible by and sometimes justified in terms of “innovation.” But it also created a great deal of downside risk for the economy—including widespread job losses and a big increase in the fiscal deficit.
Innovation is among the most powerful forces that shape human society. The improvements in the material standard of living enjoyed by most (though not all) Americans are largely due to innovation. One of the principal arguments for free-market capitalism is that it is the economic system that most encourages innovation, because it allows innovators to capture a significant part of the benefits of their work.
Today, financial innovation stands accused of being complicit in the financial crisis that has created the first global recession in decades. (See, e.g., Johnson and Kwak 2010, 105–9). The very innovations that were celebrated by former Federal Reserve chairman Alan Greenspan earlier this decade—negative-amortization mortgages, collateralized debt obligations (CDOs) and synthetic CDOs, credit default swaps, and so forth—either amplified or caused the crisis, depending on your viewpoint.