Financial innovation pioneer Rick Bookstaber predicted the meltdown in his 2007 Demon of Our Own Design: Markets, Hedge Funds & the Perils of Financial Innovation. Recently he debated the value of “financial innovations” in an Oxford-style debate at The Economist’s Buttonwood Gathering in October 2009. Nobelist Myron Scholes, the chairman of Platinum Grove, and Putnam’s CEO Robert Reynolds argued for “financial innovations.” Jeremy Grantham the CEO of GMO was on the other side with Bookstaber. Afterwards, Bookstaber summarized his message on SeekingAlpha. Here are three of his strongest criticisms: 

Market Efficiency. Q: “Do innovative products promote growth by increasing market efficiency? A: The objective in the design and marketing of innovative products is not market efficiency, but profitability for the banks. And market efficiency is the bane of profitability. The last thing a bank would want is a competitive, efficient market, because then it would not be able to extract economic rents. So the incentives are to create innovative products that reduce market efficiency, not enhance it. How is this done? Well, I can quickly think of two ways. First, by creating informational asymmetries, by having products that are difficult for the users to understand a price. And the second is by designing innovative products, which, due to their non-standard nature, allow the banks to extract higher transaction costs.” (More)

Warning, quants, the grand magicians of the illusionary arts of behavioral finance and neuroeconomics, of investment psychology and the “new science of irrationality,” are working with Wall Street’s new “Happy Conspiracy” to scam America’s 95 million investors. They are your enemies. You cannot trust them. Their new books, ads and press releases are deceptive and misleading, part of Wall Street’s secret efforts to dominate, manipulate and control your mind, money and the markets.

This is not a review of Hollywood TV thriller like “24” involving corrupt politicians and corporations. Rather, we are targeting an emerging culture that’s far more dangerous than we just read in “Recipe for Disaster: The Formula That Killed Wall Street,” Wired magazine’s fascinating analysis of how “Wall Street turned to quants—brainy financial engineers—to invent new ways to boost profits. Their method for minting money worked brilliantly…until one of them devastated the global economy.” (More)