James Kwak had a smart post yesterday explaining why financial "innovation" isn't really innovation at all and rounding up the the usual suspects' views on the same topic. The gist is that most kinds of innovation produce benefits for consumers as well as innovators, while financial innovations -- like the mortgage-backed securities first developed by Lewis Ranieri over here -- tend to disproportionately benefit innovators over consumers: 
Microsoft and Intel together probably created a handful of billionaires and a few thousand multi-millionaires out of their employees; but for at least the last ten years, no one going there has gotten anything more than a decent salary and a good resume credential. As computers get smaller, cheaper, and faster, the benefits flow overwhelmingly to their customers – to us. And those are near-monopolies. The general pattern in the technology industry is that a few entrepreneurs make a lot of money, and the vast majority of people make a decent salary; even the highly-educated, highly-trained, hard-working software developers, most of whom could have been “financial” engineers, are making less than a banker one year out of business school.That’s the way innovation is supposed to work. You invent something great, you make a lot of money, then your competitors copy you, prices go down, and the long-term benefits go to the customers. And you and your competitors all get more efficient, meaning that you can do the same amount of stuff at a lower cost than before. If you want to make another killing, you have to invent something new, or at least invent a better way of doing something you already do.By contrast, the historical pattern of the financial sector – rising revenues, rising profits, and rising average individual compensation – is what you get if there is increasing demand for your services and, instead of competing to lower costs and prices, you limit supply. Sure, prices fell on some financial products, but financial institutions encouraged substitution away from them into new, more expensive products, with the net effect of increasing profitability (and compensation).Understanding this phenomenon is important because it's key to understanding how large a financial sector we need. It should be smaller, but finding the right balance between large enough to perform capital movement functions and small enough not to become a bubble-encouraging, economy-endangering waste of productivity.
-- Tim Fernholz
