My next door neighbour locked herself out of her home the other day when she went to take out the trash. I gave her a drive up to her daughter’s school so she could get her daughter’s set of keys. On the drive over we engaged in some normal small chat. At some point the topic came up that her daughter had gotten in some trouble over some misbehaviour. Well, specifically, her daughter had apparently lent her friend her mobile phone and said friend then sent some nasty text messages to another girl. The phone got confiscated and the daughter got into some trouble over it. The mother commented that maybe she was going to keep the phone and not return it to the daughter as punishment. She further commented that her daughter was acting out and doing things that she, the mother, didn’t like and she was considering ramping up the punishments. I commented that it wasn’t so much the punishments that acted as a barrier but the ratio of risk versus reward. Don’t ramp up the punishment, reduce the reward.

Punishment alone isn’t really enough of a motivator to stop someone from doing whatever it is they’re not supposed to do. What everyone does is simply balances the possible positive outcome against the possible negative outcome and decides whether taking a chance at attaining the positive outcome is worth having to pay the negative outcome. If the risk is worth it they’ll engage in that behaviour. Obviously this is a gross oversimplification but for the purpose of this blog post it’ll suffice.

Along this line, there’s a blog post by Becker and Posner here re-examining the wisdom in total de-regulation. Posner writes, “I suspect that the deregulation (though again partial) of banking has been a factor in the current credit crisis.” So, in hindsight, getting rid of all of the rules results in people in positions of power taking advantage of the situation for their own benefit. More so, if all risk is removed–that is, bail-outs are assured–then there is no barrier to highly risky and exploitative behaviour because all successes lead to big payoffs while failures are someone else’s problem.

And by someone else I mean you. It’s your problem.

What’s worse in this situation is banks are balancing the possible reward of a large income generated from sub-prime borrowers against the risk of, well, nothing. They got fucked and now there is talk of the government bailing them out like they do with large airlines and pretty much any other corporate welfare queen.

Anyway, if I were to ask you what would happen to a classroom of children if the teacher walked in and told them that there were no longer any rules–and we assume that appropriate proof is provided such that the children believe the teacher–I think we can all predict the outcome. Whoever believes that a banking executive who is used to getting his or her way would somehow not behave in this manner in the same situation is either delusional or ignorant.

Or an economist.