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Credit derivatives enhance the transparency of the market’s collective view of credit… and thus provide valuable information about broad credit markets and increasingly set the marginal price of credit’ – the price discovery and market efficiency hypothesis.
Lord Turner defined and described both ‘securitisation’ and ‘shadow banking’, highlighting some of the underlying drivers and characteristics that could manifest themselves in future in new specific forms.
He also analysed how and why shadow banking played a central role in the 2008 financial crisis, suggesting that ‘securitisation’ per se might have had some potential to be a useful financial innovation, but that the developments of ‘shadow banking’ were inherently dangerous.
Lord Turner in his speech also considered financial innovation. "Here I will argue that, while there clearly can be beneficial financial innovation, there are fundamental reasons why innovation and finance tends to be less likely to produce beneficial social impact and more likely to produce rent extraction, than innovation in other sectors. But arguing also that, within finance, our greatest concern should be focused on innovations which relate to the credit and money creation process, because it is there that financial innovation can produce not just zero social value but large negative externalities.“
Finance is different because the opportunity for purely ‘distributive’ activities is greater than in other sectors of the economy. And banking and shadow banking are even more different, because they are integrally involved in the money/credit creation process, which has an inherent potential to create instability and severe negative externalities.
As a result of both the ‘distributive’ and ‘negative externality’ effects, we have good a priori reasons for believing that the financial industry can attract a sub-optimally high percentage of high-skilled talent, and will be characterised by a greater divergence between marginal private profit (and thus remuneration) and social value than is found in other sectors. That implies that we should be very cautious in our interpretation of the meaning of financial sector value added in the national income accounts, and very wary of any belief that increased size in the financial sector is a desirable end per se.