We need to distinguish financial innovation from the subprime mortgage situation, and the more I think about it, the more I think that “financial innovation” has gotten a bad rap.
Selling mortgages to people with bad credit on the assumption that house prices would have increased indefinitely was a stupid idea, but I think that one could make a case, that given low interest rates, that people would have done it anyway even if there were no financial innovation.
The argument that I’d like for people to think about is that without these complex instruments, the crash would have looked more like the S&L crash of the 1980’s. As it is, the direct costs of the damage has been borne mainly by investment banks and hedge funds with large amounts of capital. Without financial instruments which effectively focused the risk in those entities I think it could be argued that the cost would have been more widespread.
Something to think about.