Financial Innovation and the Distribution of Wealth and Income

Now that Congress has passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, regulators promulgating the rules under this new bill must tackle a major problem that the reform bill addresses only indirectly. This is the problem of excessive “leverage” – financing with too much debt. Leverage permeates the modern financial system. Leverage makes the system too large, in the sense that large parts of the system operate outside the reach of regulators, and the system has a tendency to create vastly too much money and credit, thereby causing asset bubbles. Asset bubbles create the illusion that the financial sector is adding substantially more value to the global economy than it really is, and expose the rest of the economy to too much risk. Moreover, too much of society's resources go to compensate the people in the system who are causing this to happen