Innovation in the New Financial Regulatory Environment

I am pleased to be here today to discuss a topic – financial innovation – that I think is of great importance as we learn more about what caused the financial crisis and shape the future of financial regulation. Currently, many people are hostile to the very thought of financial innovation. After all, wasn't it new financial products and instruments – subprime mortgages and complex derivatives, for example – that got us into trouble in the first place? The answer here, as with many things in economics, is yes and no. In my view, the question is not whether financial innovation is inherently good or bad. Instead, we should think about whether or not particular financial innovations are improving people's wellbeing. And that, I think, is largely dependent upon the structure of the regulations and policies under which financial firms operate. Innovations in financial arrangements, like innovations in any sector, are shaped by the incentives that firms face. In many cases, those incentives align the interests of innovators with those of society as a whole. New goods or services, or new ways of organizing production, are often profitable only to the extent that they provide something that consumers value, or reduce the real costs of production. Indeed, this is why the innovations that have been the engine of economic growth for the last several centuries have resulted in such profound improvements in wellbeing.