Comments on: Shleifer vs Milken on financial innovation A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: DavidMerkel Sat, 17 Apr 2010 04:59:43 +0000 Felix, loans have strong covenants and bonds don’t. That’s the main difference.

By: o_nate Fri, 16 Apr 2010 14:26:56 +0000 I’m not sure it’s accurate to say that people will flee all “innovation” during a crisis. ETFs are a fairly recent innovation, but I don’t recall hearing anything about people fleeing them specifically during the last crisis (any more than they fled stocks in general). I think people were smart enough to realize that the particular innovation that was in trouble was structured credit. Were CLOs oversold during the crisis because of their structural similarities to ABS CDOs? Yes, they were. But anyone with the funds and confidence to buy CLOs during the worst of the crisis would have made a very nice profit. I think that CLOs will have a future, but only if they become simpler and more transparent. The basic concepts of diversification and tranching are not that hard to grasp. Diversification is already the principle of any mutual fund, and no one seems to question the rationale for those. By adding tranching, CLOs do add a layer of complexity, but it’s not really that hard to understand as a concept. The problem is that sometimes structurers make the CLOs more complicated than they need to be. I’d guess the future is probably going to be simpler structures with clear rules for assigning losses to tranches.

By: FelixSalmon Fri, 16 Apr 2010 04:22:08 +0000 Link to paper fixed

By: rfreeborn Fri, 16 Apr 2010 04:09:41 +0000 Felix –

You, at least partially, prove Milken’s point.

“In boom times, people think locally, don’t think about tail risk, and pile in to innovative financial products, which banks are happy to pump out in essentially unlimited quantities.”

If the products were properly underwritten during these boom times, the bubble wouldn’t get as big and the risk wouldn’t be as large. What would have happened if proper underwriting would have cut the knees out from under 100% LTV NINJA (No Income/No Asset confirmation) loans?

Proper underwriting, at a basic tenet, prevents stupid things from happening – regardless of the innovation.

Case in point – proper underwriting could (would??) have stepped in and identified the fundamental flaw in ratings agencies using only boom time historical data for projecting future returns.

In closing, if “financial innovation” brings us to the point where it’s, as you say, “impossible” to have a firm grip of the credit risk – who the heck is signing up to buy that??

By: HBC Fri, 16 Apr 2010 01:51:58 +0000 How on earth do either the despicable Schleifer or venal Milken get away with showing their faces in public? Only in America…

Dignifying seminars with either of them by your attendance rates close to scalping tickets to Paris Hilton and Angelyne debating the topic of virginity, only worse. Really.

By: gyago Thu, 15 Apr 2010 22:32:12 +0000 I’d highly recommend as a corrective to the limitations of Vishny,’s model which most elegantly works for describing behavior independent of capital structure and temporal changes, the paper by Michalopolous, Laeven and Levine on Financial Innovation and Economic Growth (   In short, historical observations and empirical evidence show that economic growth stops unless there is more financial innovation, not less.

Also, there is additional work demonstrating how improvements in financial contracts, markets, and intermediaries reduces inequality as well.

See: “Finance and Inequality: Theory and Evidence” (with Asli Demirguc-Kunt) Annual Review of Financial Economics 1, Palo Alto, CA, December 2009, 287-318.

Hope that this is helpful in sorting out these complex and important issues.

If not, we always have the 50+ finance panels at our upcoming Global Conference: which will delve into this debate in much greater depth.

By: gyago Thu, 15 Apr 2010 20:26:57 +0000 There’s a big difference between models that didn’t work, models that were ignored, bad and insufficient data fed into models and managers that that overode risk metrics (think 3 Mile Island)that predicted defaults and illiquidity for products and banks that were known–ex-ante–to be seriously overleveraged. As we say around here, complexity is not innovation (especially if it is opaque and designed to obscure risk) and leverage is not credit–the fundamental analysis requisite for real innovation—i.e., products and services, processes, and organizational forms–that lower capital costs, create jobs, and fund entrepreneurial change. Let’s define financial innovation properly and not simply assume it’s every Rube Goldberg capital structure that tries to dodge disclosure. Then there are the agency costs of ratings agencies and that game which deserves and is getting serious attention by the firms themselves and regulators.

By: DACoffin Thu, 15 Apr 2010 20:21:37 +0000 The link to Shliefer’s paper is broken…