“The only useful financial innovation is the ATM.” I couldn’t disagree more.

The most recent financial crisis spurred cynicism and skepticism regarding financial innovation.  Paul Volcker, the former Fed chairman, in an interview said that the only useful financial innovation he can think of is the ATM.   Many people believe the financial crisis was caused by Wall Street, thus picturing all financiers with big horns and devilish appetite to dominate the world without any positive contribution to society.

I couldn’t disagree more.

In times of crisis, we become shortsighted and we wipe out everything rational from our minds and focus on finding a scapegoat to blame.  If it is true that financial innovation is the source of all evil, causing bubbles and crashes, then if we go back in time when financial systems did not exist, it is logical to expect to see no bubbles.  However, history proves us wrong.  The most famous one of all is the tulip bubble of 17th century in Netherlands which had nothing to do with financial markets, but everything to do with human insatiable appetite to profit from pure speculation.  At the peak of the tulip mania, a single tulip bulb sold for 10 times the annual income of a laborer. When the bubble finally collapsed, many men lost their fortunes overnight.  

We do not need to go that far back in history to find more examples of crises unrelated to financial markets.  Over 30 million people died of starvation in the Chinese experiment to collectivize farming.  Chairman Moa did not rely on financial markets to starve millions of people to death.

Post the financial crisis, support for capitalism has been falling all over the world.  However, capitalism is not a static phenomenon.  It is dynamic and it is constantly being updated through innovation.   Without innovation, capitalism will wither and die.  Financial innovation allowed an average person to become a home owner.   Today, that innovation continues to bring up new ways to allow capitalism to achieve society’s goals. Three such examples are: (1) The Benefit Corporation, (2) Crowd Funding, and (3) The Social Impact Bond.

The Benefit Corporation is an entity that combines charity with profit maximizing motive.  It is a new class of corporation which has a social mission in addition to maximizing profits for its shareholders.  This innovation gave birth to Grower’s Secret, a fertilizer company, which has the mission to restore the health of our oceans caused by fertilizers washing into the waters.

Crowdfunding remains my favorite recent innovation.  The basic concept is that it allows people who believe in an idea to fund entrepreneurs who want to make that idea reality.  Next time you said “I wish I had a robot who answered all my work emails” you’d be able to check on a crowdfunding platform if an MIT geek has figured out how to make that happen – and you can invest in his idea and become a shareholder.   Crowdfunding is used to support not only for-profit-business ventures, but also for civic projects, disaster relief, political campaigns, and to support artists by fans.  An example of such platform is Wefunder (www.wefunder.com) , which helps crowd investors purchase stock for as little as $100 in the most promising new businesses around the country. On the other side, it helps startups raise funds from their most passionate users who provide product feedback, marketing evangelism, and business connections.  

The third is the Social Impact Bond. It is a bond in the traditional sense, however, repayment to investors is contingent on the achievement of specified social outcomes.  The idea is to let a free enterprise solve a social problem.  One example is the social impact bond issued by the U.K. Ministry of Justice to finance a group of activists that they hoped would help solve the recidivism problem of the U.K. prison system.  They raised £5 million from social investors who would make a profit only if the recidivism problem was mitigated as defined by the bond contract.   In the U.S. MA and NYC are experimenting with social impact bonds and interest in this type of funding is spreading across the country.

While I do agree financial reform is necessary, we should not blame all our miseries on financial markets, and we should not understate the great benefits of financial innovation.   If we describe humans as a collection of emotions and impulses – then wise regulation needs to address to restrain the animal spirits in us and help activate the circuits in our brains that will limit our tendencies for fraud, mismanagement and unethical behavior.  However, we should allow for innovation to continue to spur economic growth.  After all, bubbles are caused by investors’ animal spirits; innovation simply provides more tools to our animal spirits to act irrationally and create bubbles. With our without financial markets, human nature will find ways to create crises.  On the other hand, financial innovation can retool capitalism to solve world problems.