Good Innovation, Bad Innovation

Mortgage backed securities (MBS), credit default swaps (CDS), and collateralized debt obligations (CDO) all sound like dirty words these days. It’s tough to argue against these sentiments given their contribution to the financial crisis. While obviously a MBS or CDS couldn’t single handedly collapse the entire system, these innovations that bundled and redirected risks provided the vehicles that allowed bankers and insurers to overindulge in the risk that eventually came back to bite them.

It’s interesting though that ‘financial innovation’ has become the only ‘innovation’ with any kind of negative connotation. Innovation is usually a positive that provides new solutions, markets, technology, and jobs. I guess not when it comes to finance. Some media and the ‘Occupy Wall Street’ movement might view these kinds of tools as products that were designed with the sole goal of putting money in the pockets of bankers; and while we can sympathize with the rage and frustration, the truth is not so simple.

A perfect analogy can be found in this Bloomberg BusinessWeek article; while it initially calls CDS’s the ‘Monsters that Ate Wall Street’ it later admits that you can’t blame the financial instrument for the harm it has done any more than you can blame a gun; someone still had to load it, aim it, and pull the trigger. Both a gun and a credit default swap have valid uses, but both can be dangerous in the wrong hands. (Which leads into the discussion about regulation of both guns and these financial products, but that’s another blog.)

The point is that financial instruments like mortgage backed securities and credit default swaps are not inherently destructive. In fact, they can have positive uses like making more capital available for middle class home ownership. They’re instruments that have actually been around for a long time and are well understood by the people who deal with them. Financial innovations are powerful and can be huge game changers creating whole industries.

At WAIN Street we make the case that our Business Credit Health Index (BCH Index) provides great transparency into mid-market and small businesses and improves credit portfolio risk management. This new insight will enable more securitization of mid-market and small business loans and allow for new ways to insure business risk. These are financial innovations; but they are not BAD.

In fact, the WAIN Street BCH Index can do a lot of GOOD things for mid-market and small businesses. These are businesses that are the primary drivers of economic and job growth so they should be given every advantage the financial industry can muster. Look, the financial instruments that brought down the economy in 2008 were abused and there no doubt needs to be tighter regulation to prevent it from happening again. However, at a time when the majority of American businesses need it the most, we should be looking for innovative ways to provide them the resources they need to lead the recovery; Make Wall Street work for Main Street.