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Financial Innovation: Were There Any Benefits At All?

In a post on credit card regulation, James Kwak at The Baseline Scenario asserts that financial innovation did little to make charge cards cheaper:

If innovation doesn’t give us new products, does it at least give us the same product at a lower price? Not so much. Here is a graph of credit card interest rate spreads (interest rate minus Fed funds rate) since the end of 1994:

(Click here for bigger chart.)

But I think there are a couple of problems with this reasoning:

First, it's probably more a function of the then-historically low fed funds rate than higher credit card rates that drove the spread higher (since card rates actually declined a bit over that period). Take a look at a similar chart for 30-year mortgages versus fed funds:

Can I argue -- setting aside rising home prices -- that mortgages got more expensive between 2001 and 2005? Probably not. The low fed funds rate really does seem to be the reason behind the rising spread.

Second, there is more than one way to judge the success of securitization. Kwak cites one, but another measure is the number of people eligible to get credit, which certainly went up during the credit boom. And under this scenario, that means the pool of people getting credit cards got riskier, which could explain why card companies didn't cut rates in line with fed funds. The mortgage industry took the same approach, which turned out to be a less-than-surefire defense against the greater chance that more customers would default.

--Zubin Jelveh