Perspective # 26 – End of Financial Innovations?

End of Financial Innovations? : You almost get beaten when one talks well about Financial Innovations nowadays ☺ Newspapers are full of economic columnists and gurus – they explore in detail the jargons like statistical arbitraging, vanilla CDO’s, Synthetic CDOs etc. Revelations after revelations follows – they ‘now’ talk about how rating agencies doled out AAA ratings in return of higher fees (S&P charges as much as 12 basis points of the total value of a CDO issue compared with 4.25 basis points for rating a corporate bond) Now the experts are finding the real reason why shares of Moodys, have more than tripled to $68.60 on May 9 from $20.65 at the beginning of 2003! One wonders where these ‘know-alls’ were all these days! Many risk averse lazy fat bankers are also ‘seizing the opportunity’ and proclaim that it was their ‘water tight strategy’, which helped them survive. More disheartening is that they blindly tar Financial Innovations as it is fashionable nowadays, though the fact is that it was a combination of bonus greed plus home loans available zero money down (who realize the gains if the price goes up, and walk away unscathed if the price turns downward as the loans are non-recourse.) which created this mess.

Though there were ‘financial innovations’ like NINJA loans (No Income No Asset) the misuse and lack of regulations led the downfall. Also the 'cool financial innovation’ of slicing bad loans and mixing with good ones and distributing the losses all over the world was theoretically okay, as one even in wildest of dreams will not imagine a global total crisis as we are faced now!

Some of the innovations are scary !! Death bonds may be the most macabre investment scheme ever devised by Wall Street . As per Businessweek - "Death bond is shorthand for a gentler term the industry prefers: life settlement-backed security. Whatever the name, it's as macabre an investing concept as Wall Street has ever cooked up. Some 90 million Americans own life insurance, but many of them find the premiums too expensive; others would simply prefer to cash in early. "Life settlements" are arrangements that offer people the chance to sell their policies to investors, who keep paying the premiums until the sellers die and then collect the payout. For the investors it's a ghoulish actuarial gamble: The quicker the death, the more profit is reaped." :) :)

Hopefully better sense will prevail and ‘Financial Innovations ‘ will make a comeback soon!! ‘C’mon the show should go on!! Maybe it is also a good time to reread the award winner book - The Origins of Value: The Financial Innovations that Created Modern Capital Markets by William N. Goetzmann and Geert Rouwenhorst in which they beautifully portray Financial Innovations of good old days - Babylonian loan contracts, invention of interest in Mesopotamia, origin of paper money in China and continue with new innovations like mutual funds, inflation-indexed bonds, and global financial securities.