or advising on a merger or takeover, there is typically only one winner. they take all. tournaments like these lead to arms - race behaviour as firms seek to leapfrog one another in their competitive quest for top - dog status. in finance, this can lead to the winner being “ cursed ” and to everyone else over - competing by under - pricing risk. financial arms races are scarcely a new phenomenon. how different history might have been had chuck prince heeded jp morgan ’ s words from a century earlier : “ i made a fortune getting out too soon ”. although not new, the liberalisation of financial services over the past 30 years, and the accompanying increase in financial scale, has probably increased arms - race pressures. as banks have piled on the pounds, their fights on the beaches have intensified. the stronger those competitive forces, the quicker an arms race escalates. in what follows, i discuss three examples of modern - day arms races in the financial sector : races in return, races in speed ; and races for safety. these are examples from the past, present and future respectively. in each, a competitive battle for relative dominance results in an evolutionary equilibrium which is sub - optimal, individually and socially. they are latter - day tragedies of the financial commons. * * * * * * * * * * * * by any historical metric, the pre - crisis period was an extra - ordinary one for the financial sector. this is no better illustrated than in the returns to financial sector labour and capital. between 1989 and 2007, the nominal gross value added of uk financial intermediaries rose more than threefold, or by about 8 % on average per year. over the same period, value - added of the non - financial corporate sector rose by about 5½ % per year. more commonly - used performance measures in banking are returns on equity and executive compensation. these rose even more dramatically over the period. returns on equity for uk banks rose from on average 1 % in 1989 to 38 % by 2007. this pattern was mirrored among other major global banks where returns rose from 8 % to 22 % ( chart 1 ). the only even broadly comparable period in banking history was in the early part of the 20th century when uk banks ’ return on equity averaged 13 % ( chart 2 ). measures of executive compensation rose even more dramatically. uk bank ceo compensation rose by 13 % per year on average between 1989 and 2007, from $ 0. 5 million to $ 4.

alan greenspan : capitalising reputation remarks by mr alan greenspan, chairman of the board of governors of the us federal reserve system, at the 2004 financial markets conference of the federal reserve bank of atlanta, sea island, georgia, ( via satellite ), 16 april 2004. * * * recent transgressions in financial markets have underscored the fact that one can hardly overstate the importance of reputation in a market economy. to be sure, a market economy requires a structure of formal rules - for example, a law of contracts, bankruptcy statutes, a code of shareholder rights. but rules cannot substitute for character. in virtually all transactions, whether with customers or with colleagues, we rely on the word of those with whom we do business. if we could not do so, goods and services could not be exchanged efficiently. the trillions of dollars of assets that are priced and traded daily in our financial markets before legal confirmation illustrate the critical role of trust. even when followed to the letter, rules guide only a few of the day - to - day decisions required of business and financial managers. the rest are governed by whatever personal code of values that managers bring to the table. market transactions are inhibited if we cannot trust the reliability of counterparties ’ information. the ability to rely on the word of a stranger is integral to any sophisticated economy. a reputation for honest dealings within a business or financial corporation is critical for effective corporate governance. even more important is the way outsiders view the corporation itself. the reputation of a corporation is an exceptionally important market value that in principle is capitalized on a balance sheet as goodwill. reputation and trust were valued assets in freewheeling nineteenth - century america. throughout much of that century, laissez - faire reigned, and caveat emptor was the prevailing prescription for guarding against wide - open trading practices. a reputation for honest dealing was thus particularly valued. even those inclined to be less than scrupulous in their private dealings had to adhere to a more ethical standard in their market transactions, or they risked being driven out of business. to be sure, the history of business is strewn with fisks, goulds, and numerous others treading on, or over, the edge of legality. but they were a distinct minority. if the situation had been otherwise, the united states at the end of the nineteenth century would never have been poised to displace great britain as the world ’ s leading economy. reputation was especially important to