This weekend I have read What We've Learned From The Financial Crisis, by Justin Fox, Nov-13 issue of the HBR Magazine.
How have economics and finance changed since the crisis? One of the conclusions of the author is that economists are now more than before accepting that financial markets are inherently unstable by their nature.
I shouldn’t overstate the intellectual shift here. Most day-to-day work in academic finance continues to involve solving small puzzles and documenting small anomalies. And some finance scholars would put far more emphasis than I do on the role that government has played in unbalancing the financial sector with guarantees and bailouts through the years. But it is nonetheless striking how widely accepted in the field is the idea that financial markets have a tendency to become unhinged, and that this tendency has economic consequencesIt suggests that the fragility of the system does not allow for principle innovations to optimize risk. In other words financial engineering and quant finance is hopeless? Do derivatives not make markets safer?
We still believe that financial engineering is good and that we shall not give up on models (what maths and physics can do for new financial thinking). But we need to be aware of the innovation risk. And we know that there are exogenous risks that need to be managed on rule bases.
In general I hope that the real economy will adopt more of the financial innovations.
Picture from sehfelder