Towards "good" financial innovation

Here's a good article about how the financial crisis has changed the face of financial innovation. For me, this was the key takeaway:

[The] failure [of so many financial innovations] suggests new frontiers for financial engineering and risk management, including trying to model the mechanics of panic and the patterns of human behavior.

When a bridge over a river collapses, the engineers who built the bridge have to take responsibility. But typically, critics call for improvement and smarter, better-trained engineers — not fewer of them. The same pattern seems to apply to financial engineers...

In the aftermath of the economic crisis, financial engineers, experts say, will probably shift more to risk management and econometric analysis and concentrate less on devising exotic new instruments.

If this shift really happens (and there's some doubt that it will), I see it as a extremely good thing. Financial innovation over the last couple decades, from what I've read, has been about upping the performance of financial instruments (i.e. decreasing their risk while keeping returns constant), while ignoring the safety of those instruments (i.e. how well they hold up to systematic crises and rare events). If financial engineers shift their efforts from designing models that seem to work well to verifying that models really do work well, it will help the system become more stable over time.

Regulation should be oriented toward changing the incentives in the financial system so that this latter type of innovation becomes more rewarding than the former; no one has any doubts anymore about how important it is to avoid financial crises.

(Note: extra points for anyone who gets the picture reference...)