Innovation is the Problem

No one can accuse Paul Krugman of mincing words.

The bottom line is that policy makers left the financial industry free to innovate — and what it did was to innovate itself, and the rest of us, into a big, nasty mess.

I find it extremely hard to believe that the costs of financial innovation will ever outweigh the massive benefits, and I accept that we may be headed for a deep recession.

Why was this allowed to happen? At a deep level, I believe that the problem was ideological: policy makers, committed to the view that the market is always right, simply ignored the warning signs. We know, in particular, that Alan Greenspan brushed aside warnings from Edward Gramlich, who was a member of the Federal Reserve Board, about a potential subprime crisis.

It seems that Gramlich was right in this instance. But how many have advocates of intervention been wrong? The costs of regulatory overreaction are difficult if not impossible to discern, but that doesn’t make them any less real.