Treasury Secretary Timothy Geithner addressed the House Financial Services committee today on the need to reform regulation of the financial industry. One key aspect of the new regulation is consumer protection. Geithner remarked,

“Without adequate regulation, American families were enticed to switch credit cards with balance transfer offers at low interest rates of which they could not take advantage if they put gas and groceries on the card. They got mortgages with interest rates that shot up painfully in two years or sometimes less, and which often had increasing loan balances. They got hidden late fees, penalty rates, and prepayment penalties. These risks were disclosed, if at all, in fine print that no reasonable consumer could be expected to see and understand.”

He went on to explain that that tactics such as these were once hailed as financial innovations. These types of innovations are clearly asymmetrical—that is, great for them, bad for us. We are all now aware of other ‘innovations,’ such as bundling risky loans and selling them in bulk to firms who buy them with the intention of doing the exact same thing. These innovations contributed to our economic growth over the past few years, even as American jobs and manufacturing, the bases of real economic growth, moved to China and India.

Critics of financial regulation say, among many other things, that increased regulation will stifle innovation. Over the past year, it has become clear that many innovations are indistinguishable from scams, and these types of innovations should certainly be stifled. There is a valid argument to be made that some financial products help eliminate waste in the financial system and more efficiently bring together lenders and borrowers. But presumably, effective oversight would still allow for this kind of innovation, and perhaps even make it more effective, since well-regulated firms may be able to more easily entice investors who may be wary of new financial products. But even in the worst-case scenario, in which increased regulation significantly reduces efficiency in financial markets, it’s worth considering the alternative, that the cost of optimal efficiency might be economic collapse.

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