That spiral defined the pre-crisis arms race in financial returns. It generated an equilibrium of synchronously high returns and pay, as banks unilaterally militarised as defence against their competitors. But as in military arms races, the resulting outcome was a sub-optimally risky one. High equity returns came through risky leverage. And high pay, especially in equity-based forms, further encouraged risk-taking.17 The resulting high-leverage equilibrium sowed the seeds of the financial crisis. With hindsight, it was easy to spot this market failure, the co-ordination problem. Banks and the financial system as a whole would have been better off had there been a benign, enlightened regulatory planner, able to co-ordinate banks on a lower return equilibrium. Unfortunately, there was not. ************ Over the past decade, trading in financial markets has undergone a technological revolution.18 The frontier of this revolution is defined by speed. A decade ago, trade execution times were measured in seconds. A few years ago, they were measured in milliseconds. Today, they are measured in microseconds. Tomorrow, it will be nano-seconds or pico-seconds. For technologists, this is a “race to zero” – the promised land of zero  12  Haldane (2011a). 13  Haldane (2011a). 14  Gabaix and Landier (2008). 15  Aikman, Haldane and Nelson (2010) provide a formal, multiple equilibrium model of this phenomenon. 16  McLean and Nocera (2010). 17  Cheng et al (2010), Fahlenbrach and Stulz (2009). 18  See, for example, Foresight (2011).

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