Toward a supply-side theory of financial innovation

This paper examines the influence of this market fundamentalist thinking on the regulation of OTC derivatives markets in the US during the pivotal period between the enactment of the Commodity Futures Trading Commission Act (1974) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010). More specifically, it traces how the conventional 'demand-side' view of financial innovation played an important role in blinding policymakers to a host of pressing regulatory challenges. The objective of this paper is to start us down the path toward a more complete theoretical account of the nature, sources and potential private and social welfare implications of financial innovation. It also aspires to move us incrementally toward a more constructive equilibrium between the important insights of financial theory and how we conceptualize and pursue the objectives of financial regulation.