NewYork Times technology columnist David Pogue is mounting a campaign against those canned messages that cellular carriers play after the greeting on your mobile phone voicemail (hat tip Mark Thoma’s son) – you know, the ones that say “to leave a voice message, wait for the beep,” only they take 30 seconds doing so, for th sole purpose of chewing up the mobile phone minutes of the person calling you. (According to Pogue, multiple carrier executives have admitted that the sole purpose of these value-destroying messages is to maximize airtime and hence revenue.)
This is exactly the same kind of “innovation” that we’ve seen in financial services and in health insurance. In each case, it’s what you get when you have too much concentration, so that a small group of oligopolists can effectively agree on the same business practice that generates profits at the consumer’s expense.
Continue reading “Telecom “Innovation”” →
After the wholesale discrediting of the strong form of the efficient markets hypothesis, Robert Shiller may be the most respected financial economist in the world at the moment. This is what he has to say on the last page of Justin Fox’s The Myth of the Rational Market:
Finance is a huge net positive for the economy. The countries that have better-developed financial markets really do better. . . . I think that we’re less than halfway through the development of financial markets. Maybe there’s no end to it.
I think Shiller’s first and second sentences are almost certainly true. There is a strong correlation between having a high material standard of living and having a relatively sophisticated financial system; think of the United States, Japan, and Germany as opposed to Zimbabwe, for example. But you can’t infer that more financial market “development” is always better. (I’m not saying that Shiller necessarily believes that, but most of the defenders of financial innovation take it for granted.)
Just because something is good, it doesn’t necessarily follow that more of it is better. Take food, for example. It’s pretty obvious that over a wide range – say from 0 to 1500 calories per day – more food is better for you. For most people that range probably extends up to 2000 calories or a little more. After that, not so much.
Continue reading “More and Better” →
Our little Internet debate about reverse convertibles (my contribution here) prompted this post by Mike at Rortybomb. To simplify a little, some commentators defended reverse convertibles by saying, “it’s basically the same as writing a put option” – or, looking at it from the other side of the trade, “there are valid reasons to want insurance against a stock price falling.” To which Mike says, “just sell (or buy) the put option.”
But this is just a specific case of an important point that Mike has made before, but that is more clear when seen in the context of a specific security. Mike’s basic point is that efficient markets imply that financial innovation does not create value. The efficient markets hypothesis says that the prices of financial assets already reflect all available information; in other words, there is no such thing as a free lunch.
Continue reading “Efficient Markets and Innovation” →
Fresh Air had an excellent interview with Georgetown law professor Adam Levitin, who blogs here. It’s only 21 minutes and I recommend it if you are interested in credit cards or in financial regulation in general.
Credit cards are an interesting if perhaps extreme case of the interplay between “innovation” and regulation in the financial industry. A long time ago, someone invented the credit card. This was a real, beneficial innovation, because it allowed people to make medium-sized purchases on credit. (You could already buy a house on credit, if you put 30% down.) Let’s say that without credit, it would take you nine months to save enough money to buy a refrigerator. Now you could buy the refrigerator and then save the money; it might take you ten months with the interest, but you get to use the refrigerator for that whole time. (A refrigerator could also save you money, because it might allow you to go shopping less often, buy in bulk, and eat at home more.) All good so far.
Continue reading “Innovation, Regulation, and Credit Cards” →
(For a complete list of Beginners articles, see Financial Crisis for Beginners.)
Kevin Drum pointed me to Ryan Avent’s insightful review of Ben Bernanke’s recent speech on financial innovation. (How’s that for the Internets in action?) Bernanke’s brief was simple: to defend financial innovation in general while acknowledging that at the margin it can be counterproductive and may need to be more closely regulated. “I don’t think anyone wants to go back to the 1970s,” he said in a line that was clearly supposed to make his point. Unfortunately for Bernanke, Avent was listening closely. His rejoinder:
neither could Bernanke point to a truly helpful piece of financial innovation developed after that decade. His examples of successful financial products? Credit cards, for one, which date from the 1950s. Policies facilitating the flow of credit to lower income borrowers was another, for which he credited the Community Reinvestment Act of 1977. And, of course, securitization and the secondary mortgage markets developed by Fannie Mae and Freddie Mac in…the 1970s.
With one exception:
Tasked with defending deregulation as a source of financial innovation, Bernanke reached for subprime lending.
This helped at least partially crystallize some thoughts I have had floating around about financial innovation for a while.
Continue reading “Financial Innovation for Beginners” →