The working paper, Hardwired Conflicts: The Big Bang Protocol, Libor and the Paradox of Private Ordering, examines the darker side of the private market structures at the heart of the global financial system.
Imagine we allowed referees to place bets on the sporting events they officiated. On one level, this would almost certainly offend our sense of fair play. On another level, however, we might ultimately view this as unproblematic insofar as teams were able to freely contract with those referees willing to make credible commitments not to exploit such conflicts of interest, and so long as compliance with these contracts was relatively easy to monitor and enforce. Imagine now, however, that there exists a limited number of qualified referees, that these referees coordinate in the development of a standard form contract which does not prohibit betting on games, and that they collectively enjoy sufficient market power to ensure that these contracts receive widespread adoption. Imagine further that the costs of determining whether a referee had in fact wagered on a game are extremely high and, as a corollary, that there exists no credible threat of either private contractual enforcement or market-based (reputational) sanctions. Given these additional facts, we might be of the view that this state of affairs is likely to undermine confidence in the integrity of the game. Indeed, it is precisely for this reason that professional sports leagues prohibit referees from wagering on games. It seems remarkable, therefore, that we permit this type of activity in the most high stakes game of all: finance.