Thursday, March 06, 2008

Speaker discusses financial innovations

By Courtney Westlake

Dr. William Poole, president and CEO of the Federal Reserve Bank of St. Louis, spoke to campus and community members on Thursday evening, March 6, on the topic of "Financial Innovation: Engine of Growth or Source of Instability?" in Brookens Auditorium. Poole's presentation was part of the ECCE (Engaged Citizenship Common Experience) Speakers Series at UIS.

The Federal Reserve Bank of St. Louis is one of 12 regional Reserve banks, serving the Eighth Federal Reserve District. Regional Reserve banks, along with the Board of Governors in Washington, D.C., constitute the Federal Reserve System.

In his current position with the Federal Reserve Bank of St. Louis, Poole directs the activities of the Bank's head office in St. Louis, as well as its three branches in Arkansas, Kentucky and Tennessee. He also represents the bank on the Federal Open Market Committee, the Federal Reserve's chief monetary policymaking body.

"The markets, as we're all aware, have been pretty upset," Poole said during his presentation. "Distress in home mortgage markets, falling new home construction and falling home prices in many areas have been a focal point in the outlook for the U.S. economy for at least the past nine months."

There is "nothing fundamentally new" about the recent subprime mortgage "debacle," Poole said. There are many examples in history of innovations that led to instability, at least initially, he said, but in general, economists agree than financial innovation plays a big role in economic growth, such as the long-term amortizing mortgage, money market mutual funds and credit cards.

"Financial markets are always innovating," Poole said. "Some innovations, such as credit cards, reflect technological advances. Clearly some people borrow more than they can afford. Credit cards, however, like many other payments and credit innovations, have lowered transaction costs, improved resource allocation and thus contributed to economic growth."

Subprime mortgage lending took off in the 1990s, but default rates on subprime mortgages began to rise in 2006, when the growth in house prices began to slow down, Poole said. He claims there are five major mistakes that led to the "meltdown," with plenty of blame to go around.

But there are lessons to be learned from this occurrence and other cases of instability, he said.

"For the individual or the firm, the lessons are clear: educate yourself about the potential risks of any investment or financial transaction, understand the incentives of counterparties in those transactions and avoid putting at risk money you cannot afford to lose," he said.

Above all, the importance of financial innovation in promoting economic growth shouldn't be forgotten, Poole emphasized.

"Successful financial innovations - those that meet the market test over the long term - promote the efficient allocation of capital and contribute to raising our standard of living," he said.

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