How the Mortgage Crisis Made Us Immoral

If you own a house and I’m your neighbor, I’ll respect your property rights. It’s just the right thing to do. (Though if there’s a fire at my place, I might break in to borrow your fire extinguisher).

If you live in a nice neighborhood, you have little to fear from the more modest parts of town. (Though if your neighborhood doubles its average income, and the modest part of town doubles its unemployment rate, and you start putting gates around your community—well, you might be a little more fearful).

Which leads us to this US headline from Fannie Mae’s Quarter 1 National Housing Survey:

“Nearly twice as many Underwater Borrowers (27%) think it is okay to walk away from a mortgage if they face financial distress than in January 2010.”

Is this a moral issue? What does it mean that the frequency of the opinion has changed? That it has doubled in a year?

Economics and Morality

Most people still think it’s immoral to walk away from a debt. But those who think otherwise—that defaulting on a payment to a nameless morass of long-since-tranched, securitized asset-owners is as amoral as it gets—have grown by 100% in just over a year.

That’s pretty high growth for the amoral team.

It’s one thing to say that morality should have nothing to do with economics. And indeed, the sense of honor and justice and trust that underpins most moral behavior is socially useful. If we all acted solely in our immediate self-interest in every situation, the world would be a greedy, dangerous, Hobbesian mess.

At the same time, economic disparity writ large spells social unrest. In Greece, they riot in the streets. In Rio de Janeiro, they have a street crime problem.

In the US, we are witnessing a small version of things. People who used to feel a moral obligation to repay a debt are saying to themselves, “Heck, the big guys and companies do this all the time—if things aren’t working out, they just default, take the insurance payment, write it off, whatever. There’s nothing moral or immoral about it—it’s just dumb to do otherwise.”

Economics Can Wear Down Morality

You may think that honoring your debt is a moral issue. You may think it’s not. What’s clear, though, is that the ratio of those two views is being driven by economic changes.

The credit ratings services will take note of this, calling it a likely increase in the default rate, and a cause for downgrading securities.

But the people on the street—in both the nice and the modest neighborhoods—will experience it as a moral casualty of the economy.

It’s just one more area of human relations that will no longer be governed by the rules of “rightness,” but rather by the least common denominator, Darwinian terms of the marketplace.

And that’s not a change to be happy about.

Man Bites Dog: A Relentless Onslaught of (Online) Civility

Rodney Dangerfield said, “I went to the fights; a hockey game broke out.”

The crusty old editor says to the cub reporter, “Don’t give me dog bites man; if you’ve got man bites dog, now that’s a story!”

Something like that is happening over at Forbes Magazine, where TCU Economist John T. Harvey has guest-written a rather unusual post, titled How to Destroy the US Economy? Balance the Budget. Here are the opening two sentences:

I can think of nothing more fundamentally foolish, more unequivocally self-destructive to our economic well being today than attempting to balance the US federal budget. It is totally unnecessary and every dollar we cut from government spending is a dollar taken from someone’s income.

I say “unusual” only because the title and the opening lines lead one to believe Harvey is a raging Keynesian liberal, which one hardly expects to see in Forbes. What will the readers think!

The Emergence of the Flamers

Sure enough, initial reader comments did not disappoint. The flamers jumped on Prof. Harvey with track shoes, e.g.:

The trouble with you young people is that you do not understand the use of money. Money is a foreign element to you. You don’t even know what it looks like! All you understand is plastic, and that means borrowing.

This is absolutely asinine. You cannot seriously believe that it is more expensive for the government to provide unemployment benefits etc than it is to EMPLOY someone and then tax the salary that the government is giving them. If that’s how the system worked, the USSR would have long ago become the lone superpower.

Professor Harvey started to respond. He quickly (within an hour) answered every comment—calmly, rationally, taking every person seriously. He greeted each person warmly (“Howdy, psumba, thanks for reading!”).

He didn’t coddle (“you seem to have misunderstood my point”), but he never talked down to anyone either—no matter how tortured the logic, no matter how rude the tone.

And then a remarkable thing began to happen.

Some commenters started to get honest. The level of vitriol declined. Issues began to get discussed. Look at these excerpts from commenters:

“John I hope you come back and help me to understand [more].”

“John, I have found this discussion enlightening and fascinating. I am old school and too old to stalk you and besides I live in Arkansas..[but] see you can teach an ole dog new tricks.”

“That’s an epiphany for me. This is a very informative post. It makes perfect sense, though. I just wish more economists would be as explicit as you…This is so interesting!”

The Power of Civility

So many people, certainly including politicians, pander to the negative in all of us. It’s a cheap trick, and it works depressingly well, particularly because it’s a quick hit.

I find it gratifying when you see proof that the long game, the game of sincerity and respect and civility, when allowed to play out, is extremely powerful. Harvey’s post is less than 48 hours old at the time I’m writing this one and already civility has calmed a few beasts, added to the net economic knowledge of many, and I think lowered the political temperature of debate by a tiny but measurable fraction as well.

Harvey’s column, by the way, is called Pragmatic Economics. He is proud that his views are hard to label. And you might want to subscribe to his RSS feed, and get you some practical wisdom too.

I think Dangerfield would’ve gotten a kick out of it.

Inflation Economics: the Tooth Fairy vs. Lemonade Stands

Over the weekend, walking with a few other adults in 75-degree Holliston, Massachusetts, I observed a clear harbinger of spring: a kid’s lemondade stand in a cul de sac. The price: 10 cents per small cup. It wasn’t bad lemonade, either.

This led us (naturally) to discuss the resurgance of YouTube videos featuring beat-downs of Easter Bunny characters, and thence–again, naturally–to the going rates being paid by the Tooth Fairy. We reckon it’s a dollar.

The consensus–among 5 out of 6 adults–was that back in the day (20-40 years ago, depending on our ages), lemonade went for 5-10 cents, and the Tooth Fairy used to pay out somewhere between a dime and a quarter (that’s 10-25 cents, for our  New Zealand readers).

The astute among you will quickly calculate the implications: inflation has hit The Tooth Business far more heavily than that sugary-sour cause of tooth-decay itself, Lemonade. The  Tooth Fairy’s economic model, therefore, has been more inflation-challenged than that of the youthful entrepreneur.

Neo-classical Economics vs. Family Economics

Somebody out there will correct me, no doubt, but basically neo-classical economists suggest that people are largely rational utility-maximizers and that, markets being generally free, prices will seek levels informed by both those drivers.

The rest of us, of course, know that people are highly irrational and there is no such thing as a free market. So we are free to concoct our own theory of inflation in the realm of Family Economics.

Let’s start with the obvious fact: no rational adult would have kids in the first place. It makes no sense economically, and increasingly it’s becoming clear that it makes little sense in terms of happiness or sanity either (insanity being hereditary, since you get it from your kids.)

Let’s focus on who sets prices. Nominally, it’s the kids who set the lemonade prices, while the Tooth Fairy (aka Mom and Pop) sets rates for the tooth repo business. In fact, M&P play a big role in each.

Mom and Pop, being in the game for irrational reasons anyway, wish the best for their kids. The best, in the case of lemonade stands, means that the kids get lots of business, much gratitude and praise, and little grief from the (neighborhood) market.

The best way to achieve that goal? Subsidized low prices. The kids get high volume, praise, even tips. Parents rationalize they’re teaching the kids a valuable lesson in economics. (Of course, they’re really just teaching them the case for massive government subsidy and transfer payments, but no matter).

Then why the high prices in dental recycling? Parents, operating against their own enlightened self-interest once again, foolishly seek love and affection from their kids. They figure if they over-pay for teeth, they’ll get that much more gratitude. The fact that kids don’t effectively calibrate the difference between ten cents and a dollar somehow doesn’t register to them.

And as if that weren’t enough, the fight for kids’ love extends to the competition from the perceived love the neighbors’ kids get from their parents. "But Johnny got five dollars from his tooth fairy" is the surest way to generate a round of neighborhood inflation.

Behavioral Economics

There are several new approaches to economics out there, loosely aggregated under the term "behavioral economics." All aim to make sense out of otherwise nonsensical behaviors–seeing utilitarian maximization in people sacrificing their lives for the species’ sake (a la lemmings), that kind of thing. 

But sometimes, I think, the  search for meaning is simply doomed. Furthermore, if all behavior  makes sense on some scale, then there’s  no such thing as stupid. This is a dangerous belief, since if there’s no stupid, then there’s not much against which to contrast the opposing virtue.

A case in point may be parental love for children.  Kids–they break your bank, break your heart, yet still the human race engages in the eternal race to propagate. Go figure.

What sense does it make? Not much.  But  why should it have to make sense? It’s an "is" thing.

Let’s just call it human economics and move along, move along, nothing to see here, just move along…



Anna Bernasek on the Economics of Integrity (Trust Quotes #6)

Anna Bernasek is author of the just-published book The Economics of Integrity

No stranger to the subject matter, she’s been a regular contributor to the Economic View column in the New York Times. She has been a staff writer covering finance and the economy at Fortune Magazine, TIME Magazine and Australia’s Sydney Morning Herald newspaper. She has frequently appeared as a guest commentator on broadcast media including CNN, CNBC, public television and NPR.

CHG: Welcome to the Trust Quotes series, Anna. Let’s lead with your book, if you don’t mind. What’s the central thesis of The Economics of Integrity? Or theses, if that’s too limiting?

AB: If there’s one thing I’d like readers to get out of my book, it’s that integrity—or trust if you prefer—is an economic asset. Once you understand that, you can think about the topic without being limited by the conventional idea that integrity is a personal virtue, and that it’s costly. If one approaches it in the right way, integrity isn’t a cost at all. It’s an investment opportunity, a way to build wealth. That’s very exciting because there’s no upper limit to how much trust—wealth—we can create. I think it’s the biggest opportunity we face.

CHG: You use several examples of inter-dependence to make your point about integrity; care to share one?

AB: Well, one of the points I try to make is that integrity—in the sense of trust and interdependence—is an abundant fact that is found literally in every aspect of our economy. For me, a good example is milk. There are about 15 people who are directly involved in making a gallon of milk. Think of the farmer, the vet, the milk hauler, lab technicians at the milk plant and so on.
If you include all the people who are indirectly responsible for making milk the number grows exponentially. When everyone does what they say they are going to do they all benefit. If one cuts corners or does the wrong thing it can hurt everyone in the chain. That’s why integrity is a shared asset. We share in the rewards of integrity but we also share in the risks.

CHG: What do you believe is the most controversial point you’re trying to make? Controversial, that is, compared to current received wisdom?

AB: Not everybody gets my ideas right away. There are two classic responses to my book, usually from people who haven’t read more than a few words of it. The first is what the heck am I talking about, can’t I just pick up the paper on any day and see that nobody has any integrity anymore? And the second is that, well, there’s nothing new here because we always knew that trust is important.

I would say this. To anybody who says we are lacking in integrity, you don’t need to think very hard to see that if we totally lacked trust in our institutions and fellow citizens the economy would be back in the stone age. We are where we are because generations upon generations have through trial and error, with great effort and sacrifice, bequeathed to us an advanced society where our wealth and our economy depends on an enormous stock of integrity.

It’s so ingrained that we take it for granted, and most people can only think of the defects in our collective integrity assets. I’m saying it’s there, it’s enormous, and it’s very important. It’s an opportunity, not a problem. Sure there are places to improve. But that’s the point—let’s do that and we’ll benefit.

To those who say there’s nothing new here, I have to admit that I didn’t exactly invent or discover trust and integrity. But in mainstream economics trust is treated in an offhand way. It’s typically an assumption on which an intellectual superstructure is then constructed. I’m saying something new: integrity is an asset, and therefore has the property of quantity. Not easy to measure, but still a quantitative subject. We can create it, invest in it, and diminish it as we choose. What I’m saying is that integrity is not just related to, but integral to wealth.

CHG: Are you using the terms ‘trust,’ ‘integrity,’ and ‘virtue’ to mean largely the same thing, or do you see particular relationships between them?

AB: I make a distinction between integrity in its colloquial sense and integrity as an economic asset. In ordinary conversation, integrity is a personal quality. That suggests personal ethics and morality, desirable and virtuous qualities in anyone. When I talk about integrity insofar as it relates to the economy, I am talking about relationships of trust.

In economic terms it doesn’t matter how pure your soul is if nobody knows about it. But if somebody respects you and trusts you, then you have something valuable. So I use the word integrity to describe a relationship of trust between persons or institutions. That trust is an economic asset and it’s very valuable. It underlies everything we do.

CHG: You write that the recent financial crisis was first and foremost a crisis of integrity. To what extent do you think we—government, business, the public—have learned this lesson (or not)?

AB: I think a lot of people recognize that what I’m saying makes intuitive sense. The issue for many people, and the reason I wrote the book, is that they don’t have the tools and concepts they need to think deeply about the problems we have experienced with integrity and about the solutions we need to go forward. It’s not going to cut it anymore to say that we need to deregulate financial markets and encourage financial innovation. But what is going to replace the rhetoric of deregulation? I think my book has some pretty good answers.

CHG: You’re a fan of disclosure in financial markets; how far can disclosure along take us? What else has to happen to increase trust in financial markets?

AB: Disclosure is probably the single most crucial step we can take. But it can’t happen in a vacuum. If there are no norms and guidelines, disclosure becomes an exercise in futility as enormous quantities of irrelevant information obscure what’s really going on. We need to get the important and relevant information out there in a fast, organized and convenient way.

But look at the tools we have now. The internet is the greatest tool ever invented to get this job done. And once we have norms and guidelines, we need to have accountability so that they aren’t just ignored. It’s a big job, no doubt, but the payoff is even bigger. We simply can’t go back to where we were before the crisis. It’s a broken system.

CHG: You’ve written recently about our health care situation, and the recently-passed legislation. If legislators had read, and absorbed, your book (it’s a hypothetical, I know), what would they have done differently?

AB: Just about everything, I’m sorry to say. There are a couple of key points that are hidden in plain view.
First, our existing system is grossly inefficient. On the whole we are paying way too much for health care and we’re not getting results. Second, our system is grossly unfair. Everybody is getting care, but not at the right time or place and certainly not at the right cost. That’s actually making people less well than they could otherwise be.

And along the way, a minority of people are being bankrupted or severely burdened financially in a way that literally adds insult to injury, while others–including caregivers, taxpayers and local communities–are bearing inappropriate burdens.

Every other developed nation—every one—has a better system. There are existing, proven, tested, popular solutions that are being ignored. The biggest travesty of the whole legislative process was the calumnious abandonment of single payer.

Only single payer moves us significantly forward. Everything else, no matter what desirable features it has (and there are a few positive things in the legislation) further entrenches a bad system and endangers not only our future health but our economic prosperity. The only thing I like about the recent law is that it is proof that change can happen. But it wasn’t the change we need.

CHG: I’ve often thought of brands as the corporate equivalent of personal trust. What is, in your view, the relationship between personal trust and corporate, or systemic, integrity? Can you have systemic trust without personal integrity?

AB: Personal integrity is a building block for corporate integrity. Of course you can imagine a situation where someone has a defect in personal integrity but it doesn’t affect their institution because it isn’t relevant to the institutional context. However, I don’t tend to think that’s the norm.

CHG: You talk about the DNA of integrity. Is integrity born, or can it be made? Can we develop integrity, or must it come with mother’s milk? How long does it take?

AB: Integrity can be created. And I think that’s what’s so exciting about it. I think a good example is eBay. From scratch eBay created an integrity system where buyers and sellers came together in a relationship of trust to create wealth. The more people heard about the good experience, the more people were encouraged to try eBay and it created a self-reinforcing system of integrity and wealth.
It can take decades to create integrity or it can literally happen overnight. It depends on whether the DNA of integrity is present (disclosure, norms and accountability) These three conditions together create integrity. They are present in eBay and they are present in other integrity systems like the NYSE.

CHG: Anna, it’s been a pleasure to have you share these thoughts with Trust Matters readers; thank you very much.

AB: Thank you!

This is number 6 in the Trust Quotes series.

The entire series can be found at:

Recent posts in this series include:
Trust Quotes #5: Neil Rackham
Trust Quotes #4: Peter Firestein on Trust, Character and Reputation
Trust Quotes #3: Dr. Eric Uslaner on the Nature of Trust

The Open Letter Main Street CEOs Should Write to Wall Street

Dear Wall Street CEO:

You’ve been taking it on the chin lately. On the other hand, the only CEO Obama has fired recently came from my side of town–Main Street—so maybe you’re not so bad off.

I have a proposition for you. For both of us, actually.

I, a Main Street CEO, am going to show you, Wall Street, how to create some real value out of “thin air.” I know, you think that’s your schtick, but hear me out.

From here on out, I propose to tell the truth about our earnings.

It’s that simple. We tell the truth about our earnings–warts and all. You come to believe it. You then no longer shave your estimates of our quarterly earnings, because we will no longer smooth them by moving things offsheet, or by tweaking policies from our financial subsidiaries.

Call it the “truth factor.” It really isn’t, though. It’s simply reversing the “suspicion factor” you’ve always had in place. Remember “quality of earnings?” Well, we’re going to provide the highest quality of all; not conservative accounting, but transparent accounting.

That’s the kind of financial value creation I know you understand. But let me go further—this policy is also going to create real value—as in higher productivity, lower costs, greater customer retention, high quality, better customer service—all that good stuff that actually drives business. Here’s how.

This morning, I’m going to announce company-wide that we are no longer including short-term incentives in our performance assessment plans. Here’s why.

Every sentient businessman knows that the dumbest way to run a business is to change plans every 3 months. The smartest way to run a business is to develop a long-term plan, based on long-standing business principles and policies and on core values. Then execute on it.

It is long-term plans, executed well, that produce the best short-term results—quarter after quarter after quarter.

But somehow, in my firm and nearly all others on “Main Street,” we lost track. It started out by our saying, “if you can’t measure it, you can’t manage it,” and “what gets measured gets managed.” So we started measuring everything quarterly (OK, I admit–way shorter than quarterly).

Maybe we got that from you guys.

Now, it pains me to admit this, but somehow—I know, it sounds crazy—we just flat lost track of the simple idea that long-term management produces the best short-term results. And we started thinking that because we were measuring short-term, we had to manage short-term. After a while, nobody would take a 3-week risk. Or honor a 4-week deal. Or sign up for a 6-month customer plan.

Like I said, dumb. But it’s the truth. It’s what we did.

But no more. From now on, we’re managing for the long-term. That doesn’t mean we’re giving up on metrics—precise metrics are critical for all kinds of things, like trend analysis and trouble-shooting. It’s just that using them like a steel cable linking to performance pay and quarterly earnings is not going to be one of those uses.

Our CFO is going to stop focusing on quarterly numbers within and without the firm. Internally, we are going to very clearly explain the long-term basis for performance assessment and goal-setting we will be using. After that, anyone found to be rewarding behavior solely for the sake of short-term numbers will be hauled before the management committee and asked to justify it in strategic terms, or to explain, "What part of long term management for performance do you not get?"

And mark my word, our earnings will go up. Because long-term management fosters relationships, trust, continuity, efficiencies, effectiveness, scale economies, customer loyalty, and employee engagement. And that makes money the old fashioned way–by creating real value.

Externally, you and yours are going to have deal with greater earnings beta from us. The quarterlies are going to be more volatile. But we’re done interpreting numbers for you.

From now on, you have to be good enough at what you do to discern the underlying pattern and explain it (hint: it will be generally NorthEast). We’ll tell you up front our policies, and show you over time how we live up to our pledge of transparency.

So my question to you, Mr. Wall Street, is do you have the guts to play the new game? My cards are on the table, as of this morning. Where are yours?


Trust-based Business Development in a Recession

We at Trusted Advisor Associates try our best to practice the Trust Principles we espouse. We have found they work for business development, as well as in other aspects of business.

We believe they are particularly relevant in a recessionary environment. That’s why we’re devoting Trust Matters this week to selling in down times.

Today’s post will set up our perspective—and the next four days will deal with business development ideas based on the Four Trust Principles, as follows:

Monday Thinking about sales from a trust perspective
Tuesday Principle 1: Client / customer focus
Wednesday Principle 2: Collaboration
Thursday Principle 3: Medium-to-long-term perspective
Friday Principle 4: Transparency

The Trust Perspective. Trust is a paradoxical thing. It requires risk-taking when we’re risk-averse. It requires doing the opposite of our first instincts.

Recessions are the same. The thing consumers want to do—stop spending and save—paradoxically drives the recession deeper. The one thing businesses want to do—cut costs, squeeze suppliers and customers, and scale back plans—paradoxically drives the recession deeper.

Trust is about relationships, not transactions. Thinking of downtimes per se is transactional thinking. Thinking of downtimes as one half of a business cycle is relationship thinking. And it’s what you do in tough times that determines how others trust you in the good times.

Trust is based on being willing to put the other’s needs first. But in a recession, the instinct to take care of Number One has the same trust-destroying effect as selfishness does in personal relationships. And it hurts business development in both the short and long run.

Trust and Business Development. We’re going to offer a few specific ideas based on these principles during the week.

What do we mean by specific ideas? Here are a few starters:

• Pick a local charity or non-profit organization; make a significant donation to them. It will be completely unexpected, very needed, and very appreciated. Don’t worry about publicity—word will get around.

• Pick a few important existing customers—you can’t help everyone—and do an important project for them, one that would normally have trouble getting done because it’s long term and visionary. And do it for free.

• Increase your severance package benefits. Now.

• Use collaboration as a form of innovation. In our business, we are working with clients to develop the Onsite Offsite, a way of delivering distance seminars at in-house costs, packaged innovatively to go way beyond traditional webinars.

Finally, one of our Trust Principles is Collaboration. We’d like to share our ideas with as many people as possible. We invite you to pitch in and make this a truly collaborative week by adding in your own comments and ideas.

Stay tuned to Trust Matters this week.



What’s the Market’s T/E Ratio Lately?

Yes, I said T/E ratio.

Not P/E, as in the ratio of price to earnings; but T/E as in the ratio of trust to earnings.

The P/E ratio of a company, industry, or market, signals many things. High P/E ratios may signal expectations of high growth, understated earnings, or low returns from alternative asset classes.

But P/E ratios also reflect levels of trust that certain things will continue to work:

• The law of gravity will not be repealed (at least not before Q4).
• The sun will set, as we anthropomorphically put it, in the west.
• Banks will still lend money to each other
• Interest rates will remain positive
• Oopsie…

P/E ratios, in other words, have a lot of co-variance with what we might call the Trust/Earnings, or T/E ratio. But while the numbers may overlap, they are not the same.

It’s one thing to have a certain level of confidence that CitiBank will work its way out of its difficulty. It’s quite another to trust that borrowers will continue to feel the same moral obligation to pay down a mortgage when 11% of borrowers are underwater. Or that they will trust their fellow man with their money in the form of government-insured deposits (interestingly, zero percent interest rates are bullish for institutional trust–it says whole lots of people find government-issue paper at zero to be safer than investing in anything).

This blog writes mostly about personal trust, not social or institutional trust. But they are related, and powerful.

Our economic and commercial world is astonishingly inter-related. If we start losing trust in the complex ways we have evolved to cooperate with strangers–banking, insurance, credit–we are all at risk.

Fortunately, we have personal, human habits, manners and customs that keep us in the habit of behaving nicely with others.

We need to make sure our institutions reflect those habits, not undermine them.

As for P/E ratios, the bad news is we are down considerably from the highs of 2002. The good news is, that was the height of the dot com silliness, and are now at the high end of average for the last 70 years.

Since no one has invented a T/E ratio (and I wouldn’t trust it if someone did), let me make a few assertions unconstrained by facts. Assess them against your own gut instincts.

The P/E ratio is much more volatile than the T/E ratio.

When the P/E ratio was in the 40s a few years ago, that was over-confidence, not over-trust. If anything, we saw the abuse of trust in commerce.

A P/E ratio now at the high end of normal might seem comforting, but I suspect that again Wall Street optimism masks not only the depth of the recession, but some erosion in the T/E as well.

A decline in the T/E is of more concern than a decline in the P/E. The world economy depends a whole lot more on us learning to trust each other—individually and collectively—than it does on interest rates.

For evidence, see the case of Japan over the last decade. Oh, you didn’t notice what happened with Japan? I rest my case.

How Obama and McCain flubbed the trust question and how they could have answered it right

In the second US presidential debate October 7th, citizen Theresa Finch stood to ask her question of the two aspirants to the office of FLOTFW (Former Leader Of The Free World).

How can we trust either of you with our money when both parties got us into this global economic crisis?

A perfectly fair question any day; an especially relevant question these days. And—since this was an overt trust question—let’s talk here about what the answers were, and what they might have been.

Let’s begin with the Trust Equation (credibility + reliability + intimacy, all divided by self-orientation) as a route into the question. What constitutes a good answer to the “why should we trust you?” question? Salespeople have to face this question all the time. Let’s see how The Two answered it.

Answer A “Well, look, I understand your frustration and your cynicism, because… you’ve got a family budget. If less money is coming in, you end up making cuts. Maybe you don’t go out to dinner as much. Maybe you put off buying a new car. That’s not what happens in Washington. And you’re right. There is a lot of blame to go around.” [Proceed to attack other and promote self.]

Answer B Well, Theresa, thank you. And I can see why you feel that cynicism and mistrust, because the system in Washington is broken.” [Proceed to attack other and promote self.]

Their answers are nearly identical. Their first words were to channel Bill Clinton, minus the sincerity. “I understand your frustration. You’re right. I can see why you feel….”

Trust hint 1 Do not assert, after hearing a total of one sentence from a stranger, that you “understand what you mean” or “can see how you feel.” You don’t, you can’t, and even if you could, it’s a form of arrogance to assert it. Low marks on intimacy (faking it) and on self-orientation (clearly focused on their own agenda).

Trust hint 2 Avoid the non sequitur. If there’s a logical link between the faux Clinton opening and the blatant self-aggrandizement that follows, at least give it a few sentences to establish the logic. Low marks on credibility (illogical), and again on self-orientation.

Trust hint 3 At least attempt to answer the question. Their concluding sentences—which ought to close the loop on the question—were “The key is whether or not we’ve got priorities that are working for you,” and “I know how to fix this economy, and eliminate our dependence on foreign oil, and stop sending $700 billion a year overseas." Huh? Say what? Again, high self-orientation and low credibility.

Robert S. McNamara, Secretary of Defense during the Vietnam War, said, “Never answer the question they ask; answer the question you want to answer.” Was there ever a better reason to mistrust someone than that philosophy? Yet it persists in politics.

In fairness: how can you be trusted when you need 51% of the vote—every vote?

Let’s hear from you. How might either candidate have answered? To get us started, I’ll take a shot at it.

“Theresa, I happen to think that’s the most important question of the night. Lack of trust is what lies beneath liquidity and solvency in our banking crisis; is what’s causing us to spend massively on defense; and is costing us a mint in wasted litigation and transaction costs.

You’re right to point out that both political parties have mud on their hands. Regaining trust lost is doubly hard; and the country doesn’t have the luxury of saying ‘wait and judge us on our track record.’

So my answer is, partly—because you have to. We have no viable third party, and we’re still a stable democracy. Only we two are running. Still, that’s a big choice. You can choose X, or you can choose Y. Whichever you pick, a lot of people will agree, and many more will disagree with you.

Given that you’re stuck, the answer to “how will you trust” has got to morph into “what can I do to help make us a better country?” And I’d say this: hold us accountable. Don’t fall for us when we talk down to you in slogans. Write letters. Engage. Open your minds. Read magazines and blogs. Change the channels. Go talk to someone you disagree with. Don’t settle for someone who panders to the lowest common denominator. Figure out how to trust someone who’s leaning to vote the other way—then tell us all how you did it.

You want to trust one of us? Demand that we be worthy of your trust. Don’t settle. And why should you trust one of us? Because if you don’t, and don’t work at your part of it, you just withdraw from the game. And we need you to play your part.

Over to you. Post your own “why should we trust you” answer right here. I will personally pass on the winning answer to my good buddies Barack and John (both of whom could use it).

(Thanks to Stewart Hirsch for suggesting this post).



Failing Trust Has Led to Failing Markets

Trust has taken a leap to the foreground given the implosion of financial markets. And rightly so.

Irish economist and market researcher Gerard O’Neill writes:

"…the essence of the present financial crisis is a collapse in trust: including trust between banks and other banks; between banks and their customers; and indeed between banks and governments."

O’Neill cites a BBC program that asks the question, “Is trust evaporating in contemporary society? Does more monitoring of people and politicians increase trust, or encourage paranoia?”

Robert Reich, former US Labor Secretary turned academic, has also been waxing eloquent on the subject, on TV Talk Shows and on the radio:

…why are the free marketeers in the Bush Administration rushing to Wall Street’s aid? The answer goes deeper than the subprime mess. The Street has suffered a serious decline in trust…Yet trust is its most important asset. Financial markets trade in promises — that assets have a certain value, that numbers on a balance sheet are accurate, that a loan carries a limited risk. If investors stop trusting those promises, Wall Street can’t function.

…It worked great as long as everyone kept trusting and the market kept roaring. But all it took was a few broken promises for the whole system to break down.

There are two debates going on now. One is political, built on pent up resentment and schadenfreude—the Main Street vs. Wall Street argument. The other is ideological—free markets vs. regulation. Both are somewhat bogus, but I’ll stick to the second.

Pure free markets exist only in economists’ imaginations—thank god. Competition is inherently instable. The goal of every competitor is not to maintain a state of competiton, but to obliterate that state—often by colluding, sometimes by winning. Imagine a football game without referees. Every functioning market needs some regulation to avoid imploding into a black hole of monopoly.

But neither is “more” regulation the right answer. Regulation by bureaucrats, cronies, incompetents or the venal is not much better than anarchy.

“Who” and “how” are critical regulatory questions. And there are some basic principles. You’d think they’d be obvious, but they are frighteningly easy to lose track of.

One is transparency. Nothing cuts out envy, suspicion, and temptation better than sunlight. Yet the SEC and Congress allowed an entire set of financial products and markets to be invented—out of sight. Opponents of mark-to-market accounting—please explain to me how politicians can make valuations more transparent than accountants plus a market can do?

Another is time. The more fragmented and transactional the business model, the more is needed some timeframe over which society can see relationships and consequences between those transactions. If the industry manages itself solely through zero-sum one-off deals, then regulators must provide that longer-than-a-nanosecond view.

A third is the connection of the parts to the whole. The mortgage industry is a perfect example: it used to be that mortgage agents, lenders, home-owners and mortgage-holders interests’ were all aligned. A year ago I wrote about a 1995 economists’ view of the industry as it looked then, vs. the disaster-in-the-making it had become. The difference was all disconnected parts with no one minding the holistic store—no one in industry, no one in regulation.

I usually write about personal trust; that’s the “pure” version of the stuff. But make no mistake, trust is critical socially. Some industries can self-regulate, based on the three principles above. Though just now, offhand, I can’t think of any examples.


Wall Street and Broken Social Trust

I’m hardly the first to cast the financial meltdown in terms of broken trust. But usually that means something like "we can’t trust they’ll still give us credit." There is a much deeper, distinctive pattern that leads to broken trust, and it works the same personally as it does socially and economically.

That pattern is the fragmentation of relationships. When relationships are turned into transactions separated by time or space—the predictable result is a lowering of trustworthy behavior, resulting in a lowering of trust.

Here are a few examples:

• Marriage researcher John Gottman says that couples who argue can be quite successful—they remain engaged, in relationship. It’s when the parties disengage, withdraw, refuse to interact, that the marriage is doomed. The relationship is fragmented—trust disappears.

• The airline industry in the 60s (if I recall my corporate finance cases) was funded largely by insurance companies, which lent money to the industry at large, thereby restricting competitive binges of excess capacity. When banks took over the lending, they championed specific carriers. This quickly led to over-capacity, with airlines returning to their customary unprofitable ways. A relationship of industry to industry, fragmented into competitive bank-airline duos, resulted in systemically bad results.

• If you let your teenager stay out at all hours of the night, your teenager will probably get in trouble. A family system fragmented, results in untrustworthy behavior.

• The US regulates banks and stocks. The CDOs which lay at the heart of the mortgage-driven meltdown were not regulated. No one had purview or a common interest across the entire range of financial products. A fragmented relationship, and resultant low trust.

• 30 years ago, the mortgage industry was a system of brokers, banks, and homeowners. All had a common long-term interest in that system, and all had long-term relationships with each other. With the fragmenting advent of specialized brokers, securitized loan packages and the like, no one had to relate to the whole picture, nor to each other for any length of time. Result—abuse and breakdowns of trust.

• The game theory classic Prisoner’s Dilemma pits our fears and aggressions against another player. If you both give in to fear, you both lose. But if you give, and the other person takes, you suffer the worst of all outcomes. The “trick” to successfully playing the game is to increase the number of times it is played—to create a relationship over time.  Which creates trust.

• Another prisoner’s dilemma winning strategy is to make each play more personal—face to face, looking each other in the eye, handshakes. A relationship as opposed to an impersonal connection. Resulting in more trust.

• Pure economic competition is unstable, because all competitors strive for their competitors’ elimination—the absence of relationship. Some form of social interference—rules, regulations, time-outs, referees—is necessary to keep the game going at all.

• Jonathan Knee’s book The Accidental Investment Banker tells of the cynical investment banker acronym IBGYBG—I’ll be gone, you’ll be gone, let’s do the deal. Fragmented transactions, no long-term relationships. And no trust.

• When Marie Antoinette said “let them eat cake,” she articulated a deeply riven society. Which turned out to be untenable, especially for her. No relationship, no trust.

Fragmenting relationships can lead to growth and to scale economies. Teen-agers grow up and learn to handle freedom. Outsourcing business processes can result in larger scale and lower costs. Fragmenting the mortgage industry did result in lower costs and more liquidity. The flip side, of course, is untrustworthy behavior.

Wall Street is just one example of a broader dilemma we face in an increasingly inter-related, interconnected world. How do we balance the scale economies of fragmented business relationships, industries, and business processes, with the trust-creating power of some kind of integrative force?

Regulation is one obvious integrating force. There are also industry associations, and a sense of honor (personal, professional or societal).

We’re running a little low on self-regulation just now (see for example How to Get Your Industry Regulated and Great Moments in Self-Regulation—Financial Planners). And how’s the world doing these days on ethics, public service, and collaboration?

Personally and institutionally, the more we are linked, the more trust flourishes. The more we are disconnected—structurally or personally—the more we distrust.

Turning systems into fragmented markets can increase scale, power and performance—and raise the risk of untrustworthiness. Linking relationships is the countervailing force—the more we view ourselves and our institutions as in relationship, the more we create trust.

As the world gets smaller and more linked, we need to shift more toward the latter.