Dangerous Innovations

To innovate is to add value. That could be producer value, end user value or supply chain value. The process is both conceptual and perceptual. Yet innovation does not always carry that aura of effectiveness as recent experience with structured finance products reveals. Structured finance products have lead, in widely publicized cases, to asset loss, investment institution collapse, massive government intervention and, last but not least, consumer pain . It is innovation gone berserk! This is the focus of this article. The article starts with a definition of structured finance products and proceeds to explain how they are supposed to add value. Structured finance products are identified as investment vehicles whose value is derived from, or based on, a reference underlying asset, a market measure or an investment strategy. They generally have varying terms, payout and risk profiles. Risks associated with structured products could go all the way from the risk of losing the principal to that of total eclipse! The article continues with an identification of the structural flows of many of those products. Those range from wrong price setting and illiquidity to complexity and lack of regulation. And it concludes by stating that balancing innovation and risk is essential for innovation to add value. Structured finance products seem to have failed at that. “In some respects financial innovation makes risk management easier? Risk can now be sliced and diced, moved off the balance sheet, and hedged by derivative instruments” (Bernanke, 2007). The article relies on recent work on the issue of structured finance and the case histories of countries, corporations and consumers who suffered as a result of their failure.