Two warning signs, in particular, ought to cause alarm among regulators. The first is rapid growth. When a financial technology or product truly takes off, the surrounding infrastructure often fails to keep pace. This pattern manifests itself in many different ways, from the ability of high-speed traders to outrun the stock exchanges on which they operate to the opacity of the credit default swap market in the run-up to the financial crisis. During periods of quick growth, the front offices of financial firms often sell at a breakneck pace, while the back offices struggle to cope and the rapid flow of money relies on jerry-built plumbing. Regulators must be wary of market overheating of this sort and seek to ensure that the infrastructure of finance keeps pace with its innovators.
The second pitfall is the assumption of safety. Policymakers should remember that the false comfort of the familiar helped precipitate the crisis in the first place. In the United States, home buyers and lenders fell for the faulty notion that property prices couldn’t crash nationwide and that AAA credit ratings represented a gold-plated promise of creditworthiness. Such misconceptions are hard to uproot; after all, the Western financial system remains heavily skewed in favor of providing supposedly safe mortgages to affluent households. Introducing higher capital requirements even for those assets that appear to be low risk could be one answer.
For all the problem-solving power of finance, growth and greed can distort any good idea. But when the next financial crisis hits, its triggers will likely come from an established market, such as property, in which mainstream investors and profit- maximizing institutions have once again gotten carried away. The true innovators of finance will not be the ones to blame. They are the reason the world should look at finance with a clear eye.