10.1 Early Financial Innovations #Notebook

 10.1 Early Financial Innovations #Notebook

Innovation is driven by changes in the financial environment, specifically in macroeconomic volatility, technology, competition, and regulation. 

During the Civil War, Congress passed a law authorizing the establishment of national banks but referred only to the fact that the national government chartered and regulated them. Under the national banking acts could not branch across state lines. Although banking was essentially a local retail business, you were free to do your banking elsewhere if you didn’t like the local bank. However, most people were reluctant to do that, so the local bank got their business. 

Unexpectedly, near-monopoly in banking led to innovation in the financial markets. Instead of depositing money in the local bank, investors looked for higher returns by lending directly to entrepreneurs, and entrepreneurs sought cheaper funds by selling bonds directly into the market. 

As a result, the United States developed the world’s most efficient, and most innovative financial markets, gave birth to large, liquid markets for short-dated business IOUs and junk bonds (aka BIG, or below investment grade, bonds). Nevertheless, markets suffer from higher levels of asymmetric information, free-rider problems, and frauds.

Innovation in life insurance has been more rapid than banks. Data-processing innovations, like the use of punch-card-tabulating machines, automated mechanical mailing address machines, and mainframe computers, occurred in life insurers earlier.

Reference
Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.