Trust Lessons from Independence Day in Small Town USA, 2009

In Ludington, Michigan, on July 3 at 9:30PM, it was still light outdoors (Ludington is at the far western end of the Eastern Standard Time Zone).  So it was easy to see the ten blocks of Ludington Avenue, ending at Lake Michigan, where the next day’s parade would be held. 

Two things stood out.  One was that the street had been planted with edgings of red, white and blue petunias, especially for the fourth.

The other was that virtually the length of the parade route, at 9:30PM, was already blanketed (literally, with blankets) and personal lawn chairs (some of them rather expensive) by way of reserving those particular spots for the 1PM parade beginning on the 4th.  

No one had any doubt that every one of those chairs would be there the next day.  No locks, police patrols or citizen brigades needed, thank you very much.

Nor would that be surprising to Ludington’s citizens.  By a (very) unscientific poll, well over 50% of Ludington households don’t lock their house doors at night.  Of course, Ludington is only 20% the size of the Big City of Muskegon, 50 miles away.  But I suspect it’s not all that different in Muskegon. 

The July 4th parade in small towns in America’s Midwest is a distinctive event.  Having been to parades in my youth in towns like Seward, Nebraska and Pompey, New York, I can personally relate, despite having been citified for a few decades since.

The Fourth happens at a glorious time in the calendar, when summer is just hitting full stride.  It is unabashedly patriotic, small-d-democratic, self-congratulatory, and wildly upbeat.  Half the town marches in the parade (fire trucks, beauty queens, conservation groups, HVAC companies, mayors, school bands, veterans and—in Ludington’s case—the Scotville Clown Band, since 1903), and the other half applauds enthusiastically.  All generations are represented, all consuming copious quantities of ice cream and pop (‘soda’ to you ‘coasters). OK maybe a few beers too.  And it’s curious that the celebration of independence is such a community, collaborative affair.

You can get all fancy with trust—and I do, the rest of the year—but it bears noting that there is one simple, in your face, no-BS version of trust in towns like this. 

You can leave your car and house doors unlocked.  ‘Nuff said.

You just don’t do that in South Orange, New Jersey; which is a small town, by the way.  Nor do you do it in most cities I know of.  Fuggedaboutit. 

For those (including me) who live in lock-the-door areas, it has a faint whiff of the naïve about it.  But not to those who live in no-lock towns.  It’s real.  I know, because I remember what it was like, and I got reminded of it again this 4th.

To be fair, there are some social reasons for this.  No-lock towns usually rank very low in diversity, which means everyone feels like they understand everyone else, and they pretty much do — people most easily trust those whom they most resemble.  In small towns, the degrees of separation are very small.  And I suspect (though without data) that the population is fairly stable.  This all makes it pretty easy to trust, to preach trustworthiness, and to enforce both.

I personally resent Governor Palin and others attempting to politically hijack small town values for their own divisive purposes.  I equally resent big city people who look down on small town folk as unsophisticated; they are sadly misinformed. 

But all that’s talk for another time.  On the Fourth of July, in a small midwestern town in the US of A, the glory of what it is like to live in a trusting, interconnected community is on full display.

And along with the sunburn and too many hot dogs, it makes you feel real good.   

The Credit Crisis and Trust Networks

What do analyses of social networks and trust have in common with the subprime-mortgage credit crisis? Quite a bit, it turns out.

The NYTimes on Sept. 2, in “Can the Mortgage Crisis Swallow a Town?” introduces the Egglestons of Maple Heights, Ohio. They’re a hardworking family trying to sell their house in a market where prices are falling—because too many neighbors are selling—because banks are foreclosing—because owners bought exotic mortgage-crack they can no longer afford.

The same article describes a business victim: Mark Stefanski, CEO of Third Federal Savings and Loan, a Cleveland thrift that his parents founded in 1938.

Unlike most of his competitors, Mr. Stefanski resisted the urge to cash in on the subprime lending boom…

“The model has shifted,” says Mr. Stefanski. “It became very lucrative. But it was totally irresponsible for the sake of greed.” Not that Mr. Stefanski didn’t notice the profits to be had. “Absolutely, we were tempted,” he acknowledges. “We arm-wrestled and talked, but we decided not to change the model. We felt it wasn’t the right thing to do.”

Mr. Stefanski is no social worker. He lives in an affluent suburb of Cleveland and earned nearly $2 million last year. But he does not hide his feelings about just what went wrong in places like Maple Heights. “The whole system was based on raping the public,” he says, matter-of-factly. “Not everyone should own a home — just those who can afford it.”

Third Federal has a branch in Maple Heights, Mr. Stefanski says, and in the past, “we owned Maple Heights.” But in recent years, he says, “The predators just jumped on it.”

Third Federal’s share of the mortgage market in northeastern Ohio fell to a low of about 11 percent by 2001 from more than 30 percent in the early 1990s.

Back to trusted social networks.

There’s a lot of interest in using digital technologies to help connect people. The economic gains of lowered transaction costs from trust are real—it isn’t just a blogosphere fad.

The problem with trust is—at heart it’s an analogue function in a world of digital suitors.

Put too many degrees of separation between you and another, and trust falls down. The decay rate of trust from my LinkedIn friend to my friend’s friend is huge.

As my friend David Krathwohl says, “I’ll trust a seller’s eBay ranking to buy a book; that doesn’t mean I’ll introduce him to my daughter.”

Back to mortgages.

When a bank owns the mortgage, the bank earns money—or not—when the borrower pays back the loan—or defaults. When the owner of the mortgage is four times removed—when the mortgage is sold, then securitized, then re-sold as part of a package of collateralized debt obligations (CDOs)—that incentive is removed. The nth "owner" of the mortgage—the CDO buyer—doesn’t re-check the credit risk.

Bank regulations once addressed loose lending; there is no such regulation on the underlying credit risk for CDOs. As the Sept. 2 NY Times Magazine article "Subprime Time" describes, they depended on ratings agencies.

Like addicts seeking a faster high, banks and ratings agencies switched to the fast fees of transaction income over the longer returns of relationship banking. Ditto the ratings agencies. Ditto the securitizers.

The new system made for a more liquid market; sounds good, right? It spread risk; another good. And it substituted efficient markets for local cottage industries. More good.

But the whole thing also rested on turning relationships into transactions. This is the dark side of business process re-engineering, Web 2.0, and globalization—everything can be sliced and diced and outsourced to others in the name of efficiency and liquidity. But at each point, a diet of transactions-only starves relationships—and therefore trust.  (For a far more financially literate discussion of this dark side of liquidity, see Equity Private’s Liquid Reflections of August 31).

Degrees of separation matter. Not everyone reacts like Mr. Stefanski, and he can’t carry the load alone.

Too many degrees and you get the musical chairs game: I’ll be gone, you’ll be gone, let’s just do this deal and get out before the music stops. Greed thrives, ethics starve. As with all relationships deprived of the currency of the Real, things can get pretty transactional pretty fast.

It’s ironic. What sounds like sound principles of insurance (spread the risk), banking (liquidity), and networking (spread the contacts), end up producing endemic greed, visiting disaster on consumers, and punishing ethical businesspeople.

Trust doesn’t travel well digitally. A song loses no data when it’s digitally copied—but digital replication of trust loses heart. A "trust network" based solely on transactions is a network devoid of all but the narrowest version of trust—a track record with no memory of what it is supposed to be tracking.