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How to allow innovation without abuse?

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Kai Ryssdal: For those of you who've been hoping the credit crisis is fading away, not so fast.

Ben Bernanke said today he thinks financial markets are still "far from normal." Of course, that kind of assumes the state of play before the squeeze was normal, where only Wall Street's best and brightest had ever heard of things like collateralized debt obligations and mortgage-backed securities.

Financial innovations like that got lots of applause during the good times, but now they're taking the blame for the fix we're in.

Our senior business correspondent Bob Moon has more.


Bob Moon: Much in the way some people argue that guns don't kill people, people kill people, there's a similar argument going around on Wall Street these days: don't stifle valuable financial advances just because some greedy investors have been exploiting -- or even abusing -- the financial system.

Harvard University finance professor Josh Lerner worries about throwing out the baby with the bathwater:

Josh Lerner: Much of the caution stems from a feeling that if we are too reactive, we may end up with a series of policies that end up stifling some of that innovation and doing it in a way that ends up affecting our prosperity going forward.

Without financial innovation, Lerner says the way we live would be much different:

Lerner: It would be very limited in terms of the choices in terms of the number of options we'd have in mortgages. It certainly would be in terms of our ability to borrow money for college, what kind of investments we could make and it would also be very expensive to go into and out of investments. Essentially, financial innovation has been behind a lot of these.

Michael Lewitt is president of Hegemony Capital Management, an investment advisory firm. He argues so-called innovations are exactly what got us into the mess we're in now:

Michael Lewitt: There have been some benefits, but it has gone too far. You know, the abuses that were introduced into the system took those benefits and, you know, took a lot of them back.

Or, he says, diverted them to pockets on Wall Street. And Lewitt worries that greed isn't just siphoning away productive uses of America's money supply; it's even luring away the country's best minds:

Lewitt: What Wall Street did is it hired tons of math Ph.Ds and science Ph.Ds and instead of having them, you know, figure out a cure for cancer, they had them figure out new derivative products so that Wall Street and hedge funds could make more profits. Now listen, I believe in the free market, but the drain of intellectual capital into financial innovation and away from science and the arts and so on is a real negative.

Until recently, making a case like that might have brought a response that regulating innovation in the free market was un-American. Democratic Congressman Barney Frank, who chairs the House Financial Services Committee, traces that sentiment back to January of 1981:

Barney Frank: Ronald Reagan was a dominant political figure in recent history and in his first inaugural, he said -- exact quote -- "Government is not…

Ronald Reagan: ...the solution to our problem; government is the problem.

Frank: What exacerbated this was you had people in power essentially who didn't believe even in good regulation, so it wasn't inherent that innovation could have gotten so far ahead of regulation. The philosophical view of the times is what made that happen.

But don't mistake Frank's position though. He's committed to, as he put it, "good regulation," but like the Bush administration, he's also vocal in defending financial innovation -- and he doesn't hesitate to ridicule those who might want the pendulum to swing back too far:

Frank: I literally don't understand the concept and when people say they don't want innovation, does that mean no stock market in other words? As I think of financial innovation... You mean no mutual funds? I do not think you will find mutual funds in the Bible. Certainly not in the Old Testament, I don't think in the New Testament. At some point, people created mutual funds. That's, by my definition, an innovation.

Nobody's really arguing mutual funds should be abolished, but Hegemony Capital's Michael Lewitt says it's obvious there are some unregulated bank activities that go way beyond positive innovation:

Lewitt: You know, banks should not be allowed to hide their assets off balance sheet. That's simple. That's wrong. It should not be allowed. Investment banks should not be leveraged 30 to one, okay? Fifteen to one is enough. You know, there are a few simple things that could make the system more stable.

The experts we spoke to agree on this: the challenge will be striking a fair balance between beneficial innovation and prudent boundaries.

In Los Angeles, I'm Bob Moon for Marketplace.

About the author

Bob Moon is Marketplace’s senior business correspondent, based in Los Angeles.
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