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Four financial innovations for a new generation

While financial innovation is often associated with nearly toppling the international economic system, some entrepreneurs are preparing a different breed of financial tools.

By Contributor / November 2, 2009

Rick Wynn, founder of Inspire Capital Partners in Natick, Mass., is one of several financial innovators who are seeing opportunity for new products in the world of finance.

Sarah Beth Glicksteen/The Christian Science Monitor

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For much of the 1990s, Syracuse, N.Y., was in a slump. Major employers closed up shop. Residents trickled away. Home values fell by more than 20 percent.

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Then, in 2000, federal officials, academics, and a local nonprofit group stepped in with a solution: Homeowners could purchase what amounted to insurance against future price declines for a one-time fee of 1.5 percent of their home’s value.

Then prices stabilized – probably because of some slight improvement in the local economy.

The insurance might have kept some Salt City residents from panicking, too. Of the more than 130 homeowners who purchased the protection, no one has yet filed a claim.

“It’s one of the few cases out there where providing the insurance makes the insurance less expensive,” says Barry Nalebuff, a professor of management at Yale University in New Haven, Conn., who helped design the program.

In the aftermath of subprime mortgages and credit default swaps, investors might be excused for equating financial innovation with Wall Street shenanigans. Yet it is precisely those highly destructive missteps that are causing a new generation of innovators to find opportunities to give investors more ways to protect their portfolios, more oversight over the stocks they own, and more socially responsible avenues for their money.

“What we are looking for are products that are simple enough to be understood by average people,” says Rama Cont, director of the Center for Financial Engineering at Columbia University in New York. “Even people who sit in their bedroom and look at television all day … are exposed to financial risk because they have a mortgage,” he says.

Once individuals understand that they are exposed to such risks, they become more receptive to new instruments that can help them hedge, Mr. Cont adds.

A handful of new products are now being advanced by innovators in the financial-services sector. Whether any or all will take off remains to be seen. Such innovations need broad buy-in from the financial industry to get lift and become widely available. Still, in the shadow of the longest recession in the postwar era, they keep coming.

1. Home-value insurance

Syracuse’s home-equity insurance is one method to protect homeowners. There are others. Yale economist Robert Shiller has proposed income-linked mortgages, in which the buyer’s monthly mortgage payment would drop if the average salary of his or her profession fell, regardless of what happened to the individual’s salary.

Another is what Bob Landry, a senior executive consultant in Boston, calls a “relationship account.”

In a relationship account, the mortgage essentially becomes like a consumer’s checking account. When a homeowner deposits money into the account, it reduces the principal of the mortgage and thus lowers the interest cost and that month’s mortgage payment.

When the owner withdraws money for, say, the purchase of a car, the interest costs rise, as does the monthly payment.

“Instead of borrowing [as you do with] a credit card, you’re borrowing against a secured asset on which the interest rate is significantly lower,” says Mr. Landry, who works for information-technology services firm CGI, which is headquartered in Canada. “It’s like giving yourself little home
equity lines all the time.”