Why Banks Don’t Play It Safe, Even When It Costs Them
To understand both why the banks didn’t go further on their own and why the threat of regulation helped things along, even before the rules were agreed upon, it’s worth consulting a famous essay from 1973 by the social scientist Thomas Schelling, written on the subject of hockey helmets. At the time Schelling was writing, the N.H.L. had yet to require players to wear helmets, which had been around for decades. Players were allowed to wear them, but the vast majority did not, even though this increased their chances of serious injury, and despite the fact that informal polls suggested that many players would have preferred to use them. The problem was that, while not doing so had obvious costs, it also had perceived benefits: a player’s peripheral vision was slightly better, for one, and it conveyed a sense of toughness. As a result, players tended to believe that anyone who wore a helmet was, in effect, hurting his performance relative to everyone else on the ice.
.. Bonus clawbacks, for example, reduce the chances that bank employees will take foolish risks or engage in fraud, and so would seem to make banks “safer.” But banks are competing against each other for talent. And, in that competition, any bank that insisted on clawbacks would be at a disadvantage. Even smart traders or executives can make bad bets in financial markets. So, all else being equal, prospective employees would almost certainly opt for a contract that didn’t include the threat of clawbacks over one that did.
.. This is the paradox that Schelling’s essay exposes: sometimes, having your freedom restricted makes it easier to do what you wanted to do in the first place.