financial innovation

By the green grass
By a rubbish receptacle
I saw a newspaper
I was not very happy
There was man going around all the time
He was dishing out drugs
He was a doctor
Dishing out morphine to old ladies
I said, What about us?
What about us?
-- The Fall

I haven't and will not write much about the "financial reforms", taking place in DC because it is simply a waste of time. Until we have genuine political reform, we will not get genuine financial reform. Our financial system has been tremendously altered over the past three decades by so-called financial innovation. The only public figure to say much about this is Mr. Volcker, who has stated, and I whole-heartily agree, that this innovation has added no value to the real economy. So, it was dismaying to see Mr. Volcker trotted out in the last few weeks and be completely mute about the question of "financial innovation". Welcome to the new DC Mr. Volcker.

Today, Chris Whalen at IRA has a good piece on financial innovation. It's technical, but worth the read. First he states:

We frequently receive calls from clients and readers asking about the likelihood of the passage by the Congress in Washington of reform legislation regarding over-the-counter (OTC) derivatives, financial regulation and/or mortgage securitization. Our answer is small to none given the political trends and the state of the lobbies in Washington, most specifically the large bank lobby that protects the Sell Side monopoly in OTC derivatives and securities. The fact that Senator Richard Shelby (R-AL) is still apparently not comfortable with the entirely watered down House proposal to reform OTC derivatives, for example, tells you all you need to know. Stick a fork in it.

And:

One of the benefits of spending a lot of time talking and writing about centralized clearing as the solution to all known troubles and woes in the world of OTC derivatives and especially in CDS contracts is that it keeps the attention of the Big Media, the Congress and the regulators away from the front office and the process of creating and selling complex structured securities and derivatives. It is in the front office where the true problems reside, but notice that none of the OTC reform proposals nor the Volcker Rule go anywhere near the sales and trading desks at the large banks.

The whole piece is worth reading to understand the Kabuki reform now taking place in DC. The "financial innovations" are at the heart of our financial problems. The easiest way to understand financial innovations is they were about adding layers of paper on top of the real assets, it is simply about making money on money, providing no value to the real economy. However, what it does do, is make things tremendously more unstable. Yves Smith has written some good things on how financial innovation has been used as a new lever for Wall Street to force instability into the system. They can be used to trigger events, for example a nation's or company's financial soundness, before the real assets might actually face real problems. The latest example is the Greek Crisis. What's good for Wall Street is not necessarily good for anyone else. Move your money.