Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Alphabet Soup is not Innovation

Gillian Tett, the capital markets editor of the Financial
Times
writes (“Let us pass on the alphabet soup,
SVP”, Financial Times, December 29, 2006) that
bankers trained in science and mathematics are creating innovative
debt instruments but giving them unimaginative names with unwieldy
acronyms – the alphabet soup.

He talks about “the broader acceleration of the global
financial innovation cycle” and says “banks are responding
by inventing products at such a furious pace, they barely have time to
think up names.” By contrast, he argues that “A couple of
decades ago, when new financial products hit the markets, banks gave
them names. A host of new words crept into the investment bible over
the years, such as options, swaps or puts”.

I am unable to agree with this view. Much of the alphabet soup
today does not represent really new products. Rather it consists of
simple adaptations to the credit market of ideas and instruments well
known in equity and other markets. Compared to true innovations like
cash settled index futures, the credit market
innovations that we are seeing are minor modifications and adaptations
of well known dynamic portfolio strategies.

For decades, credit has been the preserve of the banking
system. Today, as credit breaks out of that prison and moves into the
hands of people accustomed to the joys and pleasures of vibrant
financial markets, we are seeing a lot of changes. Even the simple
idea of trading a portfolio of credits rather than a single credit
appears revolutionary though this is what equity traders have been
doing for decades now. However, all this is catch up and not innovation.

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