On Deadly Sins

Neal Gabler of the Woodrow Wilson Center laments that Wall Street reforms will never outfox human nature — specifically, greed:

If we’ve learned nothing else about investment banking over the last two years, we’ve learned that it operates like a virus. You can devise all sorts of economic antibiotics — from stricter regulation and more oversight to limiting certain institutional arrangements, as Glass-Steagall did — but sooner or later they are all bound to fail because financial instruments keep mutating to escape destruction. Investment bankers reconstitute highly risky, highly profitable schemes such as credit default swaps or unit contingent options or other exotic inventions. That’s why reform never works. It will always be outsmarted.

At least, as long as there is financial reward in outsmarting the system. Gabler notes (anecdotally, at least),

that During the long postwar economic boom, the top marginal rates hovered at 91%, removing a lot of the incentive to game the financial system. There was no point in scheming if you couldn’t profit from it. Still, the country prospered. So did Wall Street.

What changed starting in 1981, according to Gabler, is that the government started rewarding greed. “The Reagan tax cuts were hailed by conservatives as a way to unleash American initiative,” Gabler writes (by dropping the punishing, punishing, punishing, punishing, punishing top marginal tax rates — these people are really sensitive about being punished).  We succeeded in unleashing “American avarice” along with it. Gordon Gekko made his Wall Street debut in 1987.

Reward a behavior and you’ll get more of it is an article of faith in certain circles. It reminds me that one of the core beliefs behind our criminal justice system — and a style of parenting popular in certain circle — is that punishment is supposed to deter misbehavior. Crimes of passion excluded, of course, and it would be hard to argue that the creation of derivatives and credit default swaps were crimes of passion, merely of greed.

Incentives, as we have seen, don’t always work the way common sense says they should. But if Gabler’s analysis has any merit (you don’t treat viruses with antibiotics, for example), disincentivizing one of the seven deadly sins again might have a more salutary effect than trying to inoculate against it.

That would be terribly unfair, of course. The full list of deadly sins applies only to people in the lowest tax brackets.