Felix Salmon reviews here a new paper advancing the thesis "that financial innovation is, by its nature, inherently and predictably dangerous."
Left to its own devices, a market with financial innovations is very likely to end up harming investors, while still making lots of money for the innovators:
In our model, innovation benefits intermediaries who earn large profits selling securities, but hurts investors, who are lured into an inefficient risk allocation and suffer from ex-post price drops… Investors’ losses from risk misallocation may be so large as to eliminate the social value of innovation altogether.
Commenter Sprizouse posted this good insight:
Stop calling it “financial innovation” and start calling it “financial complexity”. Needless complexity was re-branded as innovation back in the 80s and that’s been a major source of our problems. Complexity is easier to condemn, because we all understand that needless complexity is fabricated game to see who can outsmart who. But when it’s called “financial innovation” it makes it sound like some great public service has been done. "Financial innovation" has been widely criticized by experts and by me here, but Sprizouse's insight may be one of the most perceptive and useful.