Volcker: Little Evidence Financial Innovation Has Helped Economy

Tall Paul is my hero. I would go further than he did in a speech in Sussex. The case can made that financial innovation of the OTC derivatives variety, which has mushroomed from 1992 onward, has been at best a wealth transfer device from the real economy to the financial economy, and has probably exacted a net cost on society as a whole.

As much as that notion might seem intuitively obvious to many readers of this blog, it would take a fair bit of certain to be impossible data gathering to demonstrate it. The beauty of OTC markets is that the information one would need resides with the dealers. They have no reason to give it up, and the regulators haven’t been and continue not to be too keen to go after it. And we are talking such a long period of time that many of the records are long gone.

But the remarkable bit isn’t that Volcker said what he said; he’s made it clear that he takes a dim view of the nonsense that the industry has chosen to wrap in the mantle of innovation. It’s that the listeners were stunned. This is yet another proof of industry narcissism: the complete and utter inability to recognize and take responsibility for the damage it has wrought.

From the Telegraph (hat tip reader Albert):

The former US Federal Reserve chairman told an audience that included some of the world’s most senior financiers that their industry’s “single most important” contribution in the last 25 years has been automatic telling machines, which he said had at least proved “useful”.

Echoing FSA chairman Lord Turner’s comments that banks are “socially useless”, Mr Volcker told delegates who had been discussing how to rebuild the financial system to “wake up”. He said credit default swaps and collateralised debt obligations had taken the economy “right to the brink of disaster” and added that the economy had grown at “greater rates of speed” during the 1960s without such products.

When one stunned audience member suggested that Mr Volcker did not really mean bond markets and securitisations had contributed “nothing at all”, he replied: “You can innovate as much as you like, but do it within a structure that doesn’t put the whole economy at risk.”

He said he agreed with George Soros, the billionaire investor, who said investment banks must stick to serving clients and “proprietary trading should be pushed out of investment banks and to hedge funds where they belong…If you fail, fail. I’m not going to help you. Your stock is gone, creditors are at risk, but no one else is affected.”