Here's a list of products that should exist but don't, or at least aren't as developed as they should be:
■ Social care insurance, to protect us from the risk of high expenses at the end of our lives.
■ ETFs which allow UK investors to invest passively in factors that have beaten the market in the long-term, such as defensives and momentum. There are global momentum and low volatility ETFs. And Paris-based fund managers Ossiam offer an ETF of low-volatility FTSE 100 stocks. But the UK industry’s development of such products has been backward, despite strong evidence that momentum and defensive investing works.
■ Products which target a given level of volatility, which automatically reduce equity exposure when volatility rises, such as those advocated by MIT's Andrew Lo.
■ House price futures. These would allow young people who fear not being able to get on the "housing ladder" to buy insurance against this risk, whilst allowing older people worried about possible future house price falls to hedge their housing exposure.
■ GDP futures, or even securities whose price is tied to the income of particular industries or occupations. These would allow people worried about recessions or risks to their industries or jobs to take a short position in them, thus in effect buying insurance. Other could go long for the same reasons they are long of equities – because they want a stake in future growth. It is surely absurd from the point of view of any principle of portfolio management to expect young people to put all their biggest asset - their human capital - into one or two baskets in the face of enormous uncertainty about the future.
■ An asset whose price is linked to aggregate profits. These would allow people worried that robotisation will destroy jobs to buy the profits that such technologies will generate. The stock market does not permit this: it is a claim upon the profits of existing quoted companies, not upon ones which don’t yet exist.
These are not for the most part new ideas. Many were proposed over twenty years ago by Yale University's Robert Shiller. So why don’t they exist?
You could argue that I'm exaggerating their benefits. Maybe. But this certainly doesn't explain their non-existence. The financial industry has been very good at developing useless or even downright dangerous products - from expensive but poor-performing actively managed unit trusts to the credit derivatives that contributed to the 2008 financial crisis. The question is: why is the industry so good at bad innovation, and so bad at good innovation?
One reason is that innovation - not just in finance but in all industries - suffers from a collective action problem: the benefits flow to everyone, not just the producers. Yale University’s William Nordhaus has estimated that companies have captured only a "minuscule fraction" of the social returns to innovation since 1948. This means that innovation will be under-supplied by rational profit-maximizing firms.
Worse still, it means that the innovations we get will not be the ones which have the greatest social benefit but the ones which providers can (mis)sell - and actively managed funds and complex derivatives have been easier to sell than good products.
Although this collective action problem afflicts all innovation, it might be especially severe in finance for two reasons.
One is that non-financial firms can mitigate the problem by establishing brand loyalty. Apple has been most brilliant at this: it has fended off competition from rival makers of tablets and MP3 players by designing its products to be especially desirable. It’s far harder for financial firms to do this: nobody would buy a GDP future merely because it has been originated by Goldman Sachs rather than Barclays. The danger that the profits of innovation will be competed away by new entrants is therefore even greater in the financial industry than in others.
Secondly, the value of financial products is greatly enhanced if they are liquid and widely traded. But the originators of products cannot ensure that this happens; liquidity is, by definition, a communal thing.
The point here is simple but depressing. The lack of good financial innovation and abundance of bad is not due to the stupidity and venality of the financial industry. It’s the product of a market failure: the inability to internalize external benefits and so overcome the collective action problem. It’s for this reason that Sussex University's Mariana Mazzucato has argued that innovation requires government intervention.
Such intervention need not be intrusive. For example, in the next downturn quantitative easing could be used to give young people house price futures or GDP-derivatives, or give tracker funds or factor trackers to everyone: this is a variant of an idea proposed by Andrew McNally in Debtonator. Such state-created demand would incentivize innovation and kick-start a liquid market.
Which brings me to my wish for 2016. I'd like to see the financial industry and policy-makers think more about how to deliver financial innovation that benefits everyone, not just bankers and fund managers. As for the chances of this actually happening…well, I have as much faith in the existence of Santa Claus.