An FDA for Financial Innovation: Applying the Insurable Interest Doctrine to 21st Century Financial Markets

Abstract

The financial crisis of 2008 was caused in part by speculative investment in complex derivatives. In enacting the Dodd-Frank Act, Congress sought to address the problem of speculative investment, but merely transferred that authority to various agencies, which have not yet found a solution. We propose that when firms invent new financial products, they be forbidden to sell them until they receive approval from a government agency designed along the lines of the FDA, which screens pharmaceutical innovations. The agency would approve financial products if they satisfy a test for social utility that focuses on whether the product will likely be used more often for insurance than for gambling. Other factors may be addressed if the answer is ambiguous. This approach would revive and make quantitatively precise the common-law insurable interest doctrine, which helped control financial gambling before deregulation in the 1990s.