Financial Products are different from drugs – though both are supposed to be solutions – the first for your wealth and the second for your health. But while billions of dollars are spent on research, development and testing of drugs, virtually nothing is spent on testing financial products, leading to large scale losses from time to time as we saw during the global financial crisis. What can be done?

 

In a paper published in USA, Eric A Posner, a law professor, and E Glen Weyl, an assistant professor in economics, argue that regulators should approach financial products the way the FDA (Food and Drug Administration) approaches new drugs. We should have something like Financial Products Agency (FPA).

 

The authors propose a simple test for determining whether a financial instrument is socially valuable or socially costly, and argue that socially costly financial instruments should be banned. 

 

This is because the potential dangers of financial instruments, the authors argue, “seem at least as extreme as the dangers of medicines.” 

 

However, the authors focus more on the US situation where high-cost, complex and synthetic concoctions abound. This is why the paper says: “We propose a new approach to financial regulation that addresses the problem of financial gambling.” The research paper continues, “It is not the main purpose of our proposal to protect consumers and other unsophisticated investors from shady practices or their own ignorance. Our goal is rather to deter financial speculation because it is welfare-reducing and contributes to systemic risk.” 

 

In that sense the idea falls far short of testing financial products like drugs. We need to test all products, not just those that are gambles like derivatives. What is your view?