Financial Innovations and Veblen’s Theory of Financial Markets

Abstract

The financial system in the 1980s was shaken by a wave of speculative finance facilitated by a massive accumulation of debt, a stock market crash, crises in the banking/thrifts sector, and episodes of price manipulation. These developments comported closely with Veblen's theory of financial markets presented in The Theory of Business Enterprise [1904]. But have repeated episodes of financial instability invalidated Veblen's later assessment in Absentee Ownership [1923] that the financial system had become virtually self-insured against crises? In this paper, we propose an interpretation of Veblen's theory of financial markets which incorporates both a tendency toward collusive stability and resurgent periods of financial instability. Within that context, we focus on the role of financial innovations. The current instability traces to a financial restructuring process often linked to a wave of financial innovations. Carter [1989, 781-786] explained how financial innovations generate an increasingly fragile financial structure. Lawson and Lawson [1990] argued that the standard view of financial innovations-as encouraged by regulations and high interest/inflation rates and