From VoxEU, Bruno Biais, Jean-Charles Rochet and Paul Woolley examine financial innovation. They argue that financial innovations have a potentially socially beneficial role but with asymmetric information between those who manage and those who consume the innovation, it carries the ‘seeds of its own destruction.’ The issue is that as an innovation looks like it is actually successful (say in providing liquidity of managing risk), managers need to be incentivized to continue monitoring performance. An example of this is investigating the risk profile of an instrument yourself versus relying on a rating agency. You want the manager to add effort in evaluating instruments but when those instruments look like they are having a good run, there is every incentive to shirk. So what you see is lots of financial success coupled with a disproportionately large increase in the returns to working in the financial sector than elsewhere. That is the one thing that is the sign that things have gone array. This means that policy-makers have to hit the information asymmetry problem head-on to improve matters. In the meantime, watch the size of the finance sector relative to the economy.