The Wall Street Journal summarizes a 2005 warning by Raghuram Rajan:
Incentives were horribly skewed in the financial sector, with workers reaping rich rewards for making money, but being only lightly penalized for losses, Mr. Rajan argued. That encouraged financial firms to invest in complex products with potentially big payoffs, which could on occasion fail spectacularly.
Rajan’s analysis also questioned the structure of certain derivatives and the role of banks. But the basic cog of this machinery is the incentive. If the individual worker is not personally exposed to risk how can she or he understand risk writ large?
In a time of existential dread, it’s comforting to assign blame to “synthetic derivatives” but no financial instrument is natural. And while the global market is more complex than ever, the men who participate in it are as simple as ever.
As Rousseau wrote in 1762: No pain, no gain.
(via Paul Krugman, for whom the lesson is also sociological.)