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Regulating Financial Innovations Without Apology

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Author Info
Pol, Eduardo () (University of Wollongong)
Abstract

This paper views the housing and credit bubble 2001-2008 in a stylized manner, namely as a sequence starting with a financial innovation in 2001 followed by the superimposition of other financial innovations leading to the prevalence of uncertainty in Knight’s sense and ending in the last quarter of 2008 with both market failure and regulation failure. This ‘debt bubble sequence’ is just a slice of a dynamic process of stupefying complexity involving ignorance in a fundamental way. Few analysts would deny that a financial innovation, namely the sub-prime mortgage,combined with market participants’ ignorance about the size and location of the risk underlying complex financial products was a critical factor conducive to the financial meltdown 2007-2008. To the extent that financial innovation does bear the blame, the most obvious question is whether anything can be done to help reduce the degree of public’s ignorance about financial innovations and to prevent destabilizing innovations from entering the market.The main claim of this paper is that society should be involved in exercising directive intelligence through an appropriate institutional arrangement over the intricacies and technicalities inherent to financial innovations. Specifically, the paper proposes a new institutional arrangement conceived with the aim of strengthening financial system reliability and breaking the ‘government regulation-financial innovation’ vicious circle.

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File URL: http://www.uow.edu.au/content/groups/public/@web/@commerce/@econ/documents/web/uow056713.pdf
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Publisher Info
Paper provided by School of Economics, University of Wollongong, NSW, Australia in its series Economics Working Papers with number wp09-01.

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Length: 28 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:uow:depec1:wp09-01

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Postal: School of Economics, University of Wollongong, Northfields Avenue, Wollongong NSW 2522 Australia
Phone: +612 4221-3663
Fax: +612 4221-3725
Web page: http://www.uow.edu.au/commerce/econ/
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Related research
Keywords: Toxic financial innovations; Knightian uncertainty; debt bubble 2001-2008; relevant regulation;

Other versions of this item:

Find related papers by JEL classification:
G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Miller, Merton H., 1986. "Financial Innovation: The Last Twenty Years and the Next," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(04), pages 459-471, December. [Downloadable!]
  2. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September. [Downloadable!] (restricted)
  3. Simon, Herbert A, 1979. "Rational Decision Making in Business Organizations," American Economic Review, American Economic Association, vol. 69(4), pages 493-513, September. [Downloadable!] (restricted)
  4. Stephen Bell & John Quiggin, 2004. "Asset Price Instability and Policy Responses: The Legacy of Liberalisation," Australian Public Policy Program Working Papers WPP04_3, Risk and Sustainable Management Group, University of Queensland. [Downloadable!]
  5. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June. [Downloadable!] (restricted)
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  6. Lerner, Josh, 2006. "The new new financial thing: The origins of financial innovations," Journal of Financial Economics, Elsevier, vol. 79(2), pages 223-255, February. [Downloadable!] (restricted)
  7. John J. McConnell & Eduardo S. Schwartz, 1992. "THE ORIGIN OF LYONs: A CASE STUDY IN FINANCIAL INNOVATION," Journal of Applied Corporate Finance, Morgan Stanley, vol. 4(4), pages 40-47. [Downloadable!] (restricted)
  8. Lucas, Robert E., 1977. "Understanding business cycles," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 5(1), pages 7-29, January. [Downloadable!] (restricted)
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