Roles of financial innovation and information technology: lessons from US sub-prime mortgage crisis and its implications for China

Abstract

The mortgage loan has evolved from a local lending instrument into a major global security and its role is unparallel to other financial instruments in the process of financial globalization. This paper explains how technology and financial innovation transformed the mortgage loan from a local security into a premier global security traded worldwide. It examines the fundamental flaws of this process and why it does not work in regards to mortgage lending and the re-securitization products that were created through financial innovation. The findings show that regulation was unable to keep pace with financial innovation, which created an environment where actors in the financial service sector were able to behave geographically irresponsibly by using information asymmetries to their advantage by participating in moral hazard activities and engaging in other immoral and unethical business practices that were centered around localized geography, which ultimately contributed to the global financial crisis. It also examines the roll of financial innovation in regard to the Lehman Brothers Mini-Bond in Hong and its role as a driving force behind China's newly emerging shadow banking sector. It concludes with a policy recommendation and its implication for China's continued economic development. © Science Press, Northeast Institute of Geography and Agroecology, CAS and Springer-Verlag Berlin Heidelberg 2012.