Empirically – financial innovation is responsible for the housing crisis and market collapse
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
First, in order for financial innovation to have a positive effect on financial intermediation, it must enable an economically productive usage of savings that would not otherwise occur. If a family is willing to pay $300,000 for a new house that will cost $250,000 to build (including land), and they can pay off a loan comfortably over 30 years, then buying a house is an economically productive usage of savers’ resources that would not occur if mortgages did not exist. But the financial innovation (a mortgage) does not make the world better in and of itself; it depends on someone else’s having found a useful way to employ financial resources. Second, financial intermediation creates value when it moves funds to places where they are more valuable—making credit more available. But it is possible for the economy to be in a state where anyone who can employ credit effectively already has access to credit—or where people arguably have too much access to credit. With the benefit of hindsight, it is easy to see that the U.S. housing sector passed this point earlier this decade. With negative-amortization mortgages (where the monthly payment was less than the interest, causing the principal to go up) and stated-income loans (where the loan originator did not verify the borrower’s income), virtually anyone could buy a new house—leading developers to build tens of thousands of now empty houses, their current value far less than their cost of construction. In short, excess financial intermediation can destroys value when it causes people to make investments with negative returns; in that case, the banks would have been better off taking their deposits and investing them in Treasury bills. So in evaluating financial innovation, we need to think about whether it promotes beneficial financial intermediation or excessive and destructive financial intermediation. We cannot say that innovation is “good” simply because there is a market for it. The fact that there was a market for new houses does not change the fact that building those houses has turned out to be a destructive use of capital.