What is David Frum talking about?

In this excerpt from the Fareed Zakaria show on CNN – which otherwise features a surprisingly good group, with Eliot Spitzer, Naomi Klein and Stephen Dubner — former Bush speech writer David Frum somehow gets away with arguing that regulators should not overreact by setting stricter rules on financial instruments because such rules would stifle innovation.

It is pretty hard to believe that someone is still saying with a straight face that unregulated risky financial instruments like mortgage-backed securities were innovative. But Frum does, and  he reveals the speciousness of his assertion by basically  saying that technology innovations of the last decade prove that the private sector is creating innovative products all around. Frum does not tell us how developments like the smart phone and internet search technology have anything to do with banking “innovations,” and that is not the kind of precise question that is usually asked of a commentator on a cable television show.

Frum goes on to cite  interest-only loans as an example of innovation in the financial sector. Although it is very arguable that an interest-only loan represents anything more than an old-fashioned giant gamble on the part of borrower and lender alike , even if one accepts it is innovative, I do not see how financial regulation would prevent this product from being marketed. Regulation on such a loan, which would probably require measures like vetting a loan applicant’s ability to pay that loan and better disclosure of the risk of the product, would not fundamentally change the product itself. Of course, stricter regulation might cause more loan applicants to get rejected, resulting in less potential profit for the bank underwriters. But stricter regulation would prevent potential foreclosures and home loan defaults. David Frum’s assertion that regulation stifles innovation in this case does not really hold water. It leads me to wonder whether he knows what he is talking about, or if he does know, whether he cares, and how he still gets away with making this argument in the first place.