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February 20, 2008
The downside of those financial innovations
Steven Pearlstein lays out the problems with the decade of financial engineering -- - Time for Wall Street to Pay - washingtonpost.com:
As the industry and its cheerleaders constantly remind us, these innovations have helped to lower the cost of capital and make the business sector more efficient and globally competitive. But what we are now discovering -- or perhaps rediscovering -- are all the ways in which all this glorious financial innovation has weakened the economy and the society it serves.
For starters, these innovations have helped to create a cycle of financial booms and busts that have a tendency to spill over into the real economy, contributing to a heightened sense of insecurity.
They have shortened the time horizons of investors and corporate executives, who have responded by under-investing in research and the development of human capital.
They have contributed significantly to massive misallocation of capital to real estate, unproven technologies and unproductive financial manipulation.
They have made it easy and seemingly painless for businesses, households and even countries to take on dangerous levels of debt.
They have given traders a greater ability to secretly manipulate markets.
They have given corporations clever new tools to hide risks, liabilities and losses from investors.
And by giving banks the tools to circumvent reserve requirements and make more loans with less capital, they have enormously increased the leverage in the financial system and with it the risk of a financial meltdown.
But far and away the greatest damage from all this financial wizardry is the obscene levels of compensation it has generated for a select group of Wall Street executives and money managers.
For when you look over the long term, at the good periods and the bad, it is obvious that the pay collected by these masters of the universe has been grossly excessive -- out of line with the personal financial risk they have taken, out of line with their skills relative to the next-best performers and certainly out of line with the returns earned by investors.
So our task as we look to incorporating intangibles into the financial system is to avoid this pitfalls. It will be a challenge, to say the least.
Posted by Ken Jarboe at February 20, 2008 10:48 AM
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