Posts

Madoff Madness: When Smart People do Stupid Things

/1 Comment/in /by

Bernard Madoff’s Madoff Securities lost $50 Billion in an apparent Ponzi scheme.

You can read about the details anywhere—try the Wall Street Journal, for example. But the details don’t answer one question.

How? How could some of the world’s supposedly smartest investors—hedge funds–have been hoodwinked by something that, in the rear view mirror, was a blatant scam?

The answer reveals a common myth about trust in business. The myth is that good businesspeople make rational decisions about trust.

They often don’t. And in the rush for “best practices,” many “good businesspeople” shortchange commonsense for wishful thinking.

I have written about the Trust Equation: the trustworthiness of an individual can be expressed as a function of credibility, reliability, intimacy, and other-orientation. Someone who rates highly on these dimensions, as seen by others, is trustworthy.

But a con man is as good as the gullibility of those who want to believe him. Let’s examine the trust equation point by point.

1. Credibility: the man was the former Chairman of Nasdaq, and remains on their nominating committee. He is known as a leader in the industry. And his own website says he has "a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm’s hallmark."

Never mind there were complaints to the SEC, questioning articles in Barron’s, unavailable data, and a one-man accounting firm of record. Don’t wanna go there, uh uh.

2. Reliability: the man had a multi-year track record of over-market returns. Regular. Dependable.

Never mind that he lacked the data, or explanations, to back up just why those returns were so steady.

3. Intimacy. Many people knew him personally; he was a regular at toney golf clubs in Palm Beach and Boca Raton.

In language we usually hear about mass murderers, acquaintance Jon Najarian said, “He always seemed to be a straight shooter. I was shocked by this news.”

And in classic Big Brother language, his lawyer stated—after Madoff’s apparent confession to operating a Ponzi scheme—stated “he’s a person of integrity.” And I’m the Pope.

Never mind that “intimacy” may be the easiest factor of the four in the trust equation to fake. It’s probably the favorite factor of con men.

4. Self-orientation. Clearly his customers thought he was generous, a regular attendee of the Red Cross Ball, a desirable acquaintance by virtue of his willingness to share advice.

Never mind his broker-dealer business model was under-powered to take advantage of his supposed insights, casting doubt on his motives. Conflicts of interest were present in the situation of a funds manager using a related broker-dealer.

Trust is a funny thing. Trustworthiness can be analyzed. But it often isn’t. Which means trust is as much about the one doing the trusting as the one being trusted.

In the days to come, the absence of regulatory action will be rightly noted. Where was the SEC?

But at the same time, let’s not forget the willingness of the sheep to be fleeced.

If it looks too good to be true, it is.

There’s no such thing as a free lunch.

An emperor without clothes is just a naked man.

We know that untrustworthy people are often greedy. We can protect against that to some extent.

It’s harder to legislate against greed and willful stupidity on the part of those doing the trusting.

When commonsense takes a back seat to greed, it’s a con-man’s market.

 

 

Do You Trust the Tech Support Folks?

/6 Comments/in /by

What is it about tech support?

We want to trust that they will solve our problem. But wanting isn’t getting.

I had lots of time-on-hold to think about this recently – that is – what bolsters trust and what detracts from it? Here are my recent experiences.

1. My computer died in my sleep. It was under warranty. I called the tech support line. When I tested the computer with the agent on the line, the video card ignited in flames!

The agent stayed calm and made sure I was safe, genuinely caring about me and my home. Then he cared about my hard drive – assuring me that it was likely to be safe as well.

Then he addressed the issue – and decided to replace my computer, rather than just the parts. He described the exchange process, and said it could take one to three weeks, but might come even sooner. It arrived in 3 business days.

2. My PDA Calendar was deleting my entries. I called my cellular carrier. I slogged through one automated system and two phone agents–repeating my identification and other security data, in addition to my issue each time. Most of the conversation was scripted apologies about my woes, repetition of what I just said, and thanks for using their service and calling them. Having exhausted the service available, the last agent rightly granted me access to the manufacturer.

At that point, my experience changed. The first person asked about my problem and for my phone number in case we disconnected. Then I was transferred to a person that already had that information on the screen and who didn’t ask me to repeat either my identification information or my issue. He assured me he would stay with me until we resolved the problem – which is what I really wanted – instead of a disingenuous apology. We agreed to break at one point, at my request. He kept his word and called me back right on time, using the number that was logged earlier. And we resolved my problem.

Net net: for my computer problem, I trusted my phone agent, and through him, his company, and will buy from them again. I trust my PDA manufacturer, and will buy another when I’m ready. I’m not so sure about trusting my cellphone service carrier, and may change next time around.

What engendered trust:

• Skipping the unnecessary script and focusing on the problem
• Genuinely caring about me, wanting to help and reassuring me every step of the way
• Being transparent about process
• Keeping promises, showing reliability
• An agent recognizing that he can’t help, and referring me to one who can, as quickly as possible.

What detracted from trust:

• Canned apologies, fake empathy, and useless thank-yous designed to meet some behaviorally observable criteria judged by “management” to serve as a proxy for genuine trustworthiness;
• Asking me for the same information over and over and over…making me doubt either their intent or their competence, or both;
• Multiple transfers without results.

That’s just me. What makes you trust tech or customer service — and what makes you cringe and wonder whether anyone really cares?

Is Trust a Substitute for Risk Management?

/1 Comment/in /by

Some financiers say the current financial crisis is a risk management issue. Unwarranted risks were taken; better risk management tools are needed.

They misunderstand the difference between risk management and trust.

Risk management is when we contract that you’ll staff my project with the best people, you’ll use best practices, charge me a fair rate, that I can terminate with 30 days’ notice, and so forth. And if you don’t do those things, you’ll be in violation of a legally enforceable agreement.

Trust is where we look each other in the eye, shake hands, and say, “we’re going to do right by each other, including changing whatever else it takes to do so.”

Risk management is for hurricanes—things, events. Trusting the weather won’t change it one whit, and can be suicidal.

But treating people like hurricanes actually increases the risk. The more you give employees lie detector tests, the more they’ll lie—“someone must be getting away with it, why else would they keep testing us?” More fine print just leads to gaming the system.

Conversely, when you trust people, you increase their trustworthiness. A client once cut short my praise of a proposed subcontractor. “Charlie, enough–if you say he’s good, he’s good—I trust you,” the client said. I instantly felt the weight of the burden of trust.

When people are involved, risk management partially raises risk. Trust lowers it. Why do the financiers have it wrong? Because they think our crisis is about securities capable of being evaluated in absolute terms. It’s not–it’s about people relationships, capable of being evaluated only in subjective terms. It’s not a crisis of derivates valuation–it’s a crisis of trust.

Trust won’t eliminate risk. Some people steal from honor boxes, and take advantage of others. I commonly hear, “Charlie, you’re naive. You need to legally enforce legal rights to copyright, employee behavior, or pricing. There are no sanctions with trust.”

In fact, there are sanctions, both carrot and stick, and they can be more powerful than contracts.

Suppose I trust a French contractor with my intellectual property. I could get a legal contract stating sanctions. If violated, I could enforce it in France. But at what cost in euros, time spent, and time elapsed?

Here’s the trust carrot. “Pierre, think of the great business you and I can do together—new markets, products, opportunities; as long as, of course, you continue to respect my property rights, we can do this again and again. This can be the beginning of a beautiful friendship.”

And the trust stick? “In the inconceivable event that you, Pierre, were to violate this agreement—not that you ever would, of course—then I would be forced to make that fact public. In a blog. In letters, emails, articles, public websites, aimed at your other business partners and potential partners, your customers, your employees. That would be most harmful to your reputation for trustworthiness, Pierre, and we both know that, so we needn’t speak more of such terrible things, now do we? We understand each other, oui?”

The common way to manage risk is with lawyers and contracts. The better way is often to create trust–over a fine French meal and a bottle of wine.

One of those ways is cheaper, faster, stronger, more pleasant. Why would I want to use lawyers when I can use trust? Why manage “people risk” like you manage hurricanes, when you can use trust instead?

(The usual pushback is how to scale trust: more on that soon).

The Cost of Broken Trust

/2 Comments/in /by

by Mark Slatin

What happens when an insatiable drive for profits permeates the culture of an organization?

Eventually you forget whose business you should be taking care of.

Consider Office Depot’s current woes. The number two office products "mega dealer" ascended to their position in large part due to their strategic focus on the education and government markets. Now they have lost favor with those same markets amid questions surrounding "pricing and other irregularities."

Consider the following as reported in the Independent Dealer Magazine’s Depot State Contract Watch:

•    After the state of Georgia raised some red flags, an internal audit revealed rampant overcharges. An industry trade publication estimated the overcharges as much as $1.2 million. As reported last February by the Atlanta Journal Constitution, the state canceled their $40 million per year contract. Georgia is not alone.
•    California: The San Jose Mercury News reported that Office Depot has agreed to repay the state of California $2.5 million for over-payments, state officials said, as they released a state audit concluding that state workers routinely failed to get the best value when buying office supplies the past two years.
•    Southeast Florida: Lee County tallied nearly $60,000 in overcharges, according to a report by that county’s internal audit department as reported by the Palm Beach Post.
•    Southwest Florida: Fox 4 News reported that in Collier County, Florida a "whistle blower" from within the company has been terminated after voicing his concern for overcharging that county’s government (WFTX video).
•    North Carolina: The office of the state auditor in Raleigh, NC announced he found overcharges under an Office Depot contract with the state purchasing agency. That audit examined six months of purchases and identified $294,413 in net overcharges through direct testing of purchase orders.
•    Nebraska: State Auditor Mike Foley has concluded an investigation showing the State of Nebraska is paying too much for office supplies because of serious pricing errors and overcharges. Overcharges ranged from less than 1% to over 400% on various items according to the report.
Office Depot’s stock has plummeted from $46.52 in May of 2006 to $1.82 earlier this week, nearly 97% drop as compared with only a 30% – 40% drop in the major stock indexes over the same time frame.

Is there a connection between their B2B pricing strategy and their poor performance?  Sales and operating margin dropped by nearly half in Q3 08′ for their B2B segment.

Time will tell the depth of Depot’s damage as investigations continue throughout the country.  Despite persistent denials by Office Depot officials, the tide doesn’t seem to be going in their favor.  Are they wrongly accused?  Simply out of alignment with their core values?  Or is this part of a strategic pricing strategy that’s become part of their culture?

Office Depot’s website defines integrity and accountability as follows:

Integrity – "We earn the trust and confidence of associates, customers, suppliers and shareholders by being open, honest and truthful in all that we do".
Accountability – "We are responsible for achieving and sustaining unprecedented results that create extraordinary value to our shareholders…"

Maybe it’s just me, but it seems like their failure to adhere to the former is impacting their realizing the latter.

With ever increasing pressure on corporate earnings, the temptation to slide down the slippery slope of profit margin improvement at the cost of integrity will rise.  If your conscience is telling you "this doesn’t feel right," listen to it.  The pennies saved won’t be worth the risk.

How many years and advertising dollars does it take to create a corporate brand built on trust?  Not only does bad publicity cause buyers to question your pricing, it causes them to re-think inviting you to bid in the first place.

What can you do to avoid the high cost of broken trust?

1. Don’t do anything in the short-term that could potentially come back to bite you in the long-term. Ask yourself, "would the buyer think this is equitable?"

2. If you work in an industry in which customers already question the trustworthiness of sellers (guilt by association), address issues like pricing head on. Don’t let pricing integrity become the "elephant in the room" that takes over the room.  Bring it up first and get it on the table.  Transparency is a precursor to trust.

3. Leadership not only has a responsibility to set the tone, it has a charge to sniff out unethical pricing behavior at all levels. Make sure your team knows that you’re not willing to cross the integrity line, not once. 

Restoring broken trust takes a lot longer than building trust; a reputation can take years to build but only seconds to destroy.
 

What’s Trust Got to Do With Respect?

/8 Comments/in /by

On the one hand, the connection between trust and respect seems clear. As Thomas Friedman put it:

I’m often asked how I, an American Jew, have been able to operate so successfully in the Arab world. My answer is simple: it is to be a good listener. It has never failed me. Listening is a sign of respect. If you truly listen to the other person, they will then listen to what you have to say.

Aretha Franklin just spelled it out.

Behaving respectfully toward others is likely to increase your trustworthiness in others’ eyes, and to make them more likely to trust you.

But should it work the other way? What if someone is disrespectful to us? Should we then behave in a less trustworthy way toward them? Should we trust them less?

There’s an equally venerable point of view that says get over it, sticks and stones may break my bones but names will never hurt me, someone can hurt you emotionally only with your permission, hear other people but do not allow your emotions to be held hostage by theirs.

Of course, sometimes name-calling is a prelude to violence; disrespect can signal untrustworthiness. Only a fool doesn’t look for a nearby exit door in such situations.

But we over-rate how often that is true.

This territory of trust, listening and respect is rife with opportunities for self-improvement. Strive to respect others—not in the ways you would be respected, but in ways the other person would consider as being respected. Which means listening, very attentively.

But when disrespected, strive to rise above it. Return respect for disrespect, by listening for motives and for understanding.

Does this mean holding ourselves to a higher standard than others? And is that disrespectful in itself?

I’d like to think not. On some absolute scale, all of us are awful at this. When you behave disrespectfully, notice it and resolve to do better in future. When someone is disrespectful towards you, notice how much like them you are, and resolve to overlook it on the spot.

December Carnival of Trust is Up

/0 Comments/in /by

 

The December 2008 Carnival of Trust is now officially up, courtesy of Stephanie West Allen at Idealawg. Many thanks to Stephanie for a fascinating set of selections.

Do yourself a favor and click through to her site to view the full set of the Top Ten selections. To whet your appetite, here are a few subjects Stephanie has selected:

–What a con man has to teach us about trust

–Seth Godin on trust

–25 behaviors that will destroy trust

–the 8 factors that go into evaluating a handshake.

And six more round out the Top Ten Trust selections this month. Fascinating stuff. Just what the Carnival should do–the tough job of screening the internet each month for interesting material on trust, and doing the heavy lifting by narrowing it down to the Top Ten. Must-trust reading.

Again, read the current Carnival of Trust here. Read past Carnivals here.

And if you’d like to submit your own blog post for consideration in next month’s Carnival, please do so by clicking here.

See you next month!

 

 

‘It’s a Wonderful Life’ Explains the Financial Crisis

/0 Comments/in /by

Frank Capra’s perennial Christmas movie “It’s a Wonderful Life” is remembered mainly for celebrating civic and familial virtues. George Bailey sacrifices his dreams for those of others, but in the end receives the greatest rewards of all.

But George was also a good industrial economist. Reluctant inheritor of dad’s Bedford Falls Building and Loan, he understood the institution’s role—to consolidate deposits into home loans, so Joe the debtor could escape the landlord tyranny of the evil Mr. Potter.

When Potter engineers a short squeeze and an angry run on the Building & Loan’s deposits, George takes the town to school on economics 101:

…you’re thinking of this place all wrong.
As if I had the money back in a safe. The money’s not here.
Your money’s in Joe’s house…that’s right next to yours.
And in the Kennedy House, and Mrs. Macklin’s house, and, and a hundred others. Why, you’re lending them the money to build, and then, they’re going to pay it back to you as best they can.
Now what are you going to do? Foreclose on them?

Fine, fine, you say. What’s that got to do with credit default swaps?

A lot.

The good folk of Bedford Falls were ready to take Old Man Potter’s offer of 50 cents on the dollar, until George Bailey personally talked them down. People were confident in him and trusted him. Trust and confidence were the coin of the realm for JP Morgan, and for George Bailey, and are again today.

Say you start a bank with $10,000 in equity. You make a $6,000 loan. You’ve got $4,000 left. If you loan that $4,000, you’re tapped out. That’s when you discover deposits, aka liabilities, which let you make many more loans, aka assets.

The amount by which you can leverage your equity to make more loans depends on how stable your assets and liabilities are. If you make bad loans, your asset quality declines. If you take on bad liabilities—securitized mortgages or CDOs, let’s say—then you may have to sell assets to cover your obligations.
Presto, there’s your bank run.

The run may be driven by Bedford Falls’ rubes, or by some Old Man Potter from Greenwich, but a run is a run is a run.

If someone doesn’t trust your balance sheet, the whole structure unwinds. It starts out as a liquidity crisis. Then it morphs into a solvency crisis. Finally it is revealed for what it is—a crisis of trust and confidence.

Is it really that simple? How could Hollywood possibly get something so much more right than the risk-meisters of Wall Street?

Yes, Virginia, it really is that simple. One thing Hollywood knows is that the true story is always about character development. The rest is just updated movie sets, hot off the street dialogue, and the latest “it” actors. But the thing that art imitates is–life. Character. Trust and confidence.

George Bailey’s character development lay in realizing his power to create trust and confidence in his community.

Any parallels with incoming presidents and the potential for good they may have exist strictly in the movies in your heads. (Which after all is where trust and confidence reside, not in risk models.)

Do You Trust Detroit?

/5 Comments/in /by

My clients usually assume that subject matter expertise is the biggest driver of trust.  Usually, they’re wrong—greed, self-orientation and an inability to take personal risks are often the culprit.

But not always.  Sometimes, incompetence matters.  Detroit is one of those cases.  In a post  by Om Malik, The Market Meltdown and the Question of Trust, Malik suggests the Big 3 have lost touch with commonsense. 

Malik is an optimist. 

Allow me to demonstrate.

Toyota introduced the Prius in 1997.  11 years later, GM brought us–the Hybrid Escalade.  The Big 3’s CEOs fly their private jets to Washington to beg for money without a plan.

This level of cluelessness is not random; it is the result of 50 years of really bad management. Detroit became the East Germany of American management.  Here’s one small measure of just how they did it.

Ward’s Automotive Yearbook, the Bible of the US industry, used to annually publish US market share statistics—for models of US produced cars.  For the others, one size fit all—the line item was called “imports.”  The official stats-keeper of the industry tracked 50-60 US car models, but lumped together Rolls Royces with Toyotas and Volkswagens.

In 1963, “imports” totaled 386,000–5.1% of the US market.

By 1967, “imports” were 7.3%–still combining Nissans and Maseratis in one category, while giving the AMC Rebel its own line on the chart.

In 1968, “imports” hit 9.3%; in 1972, 12.6%. The market share table listed 59 separate US passenger car models, yet the 1.2M “foreign imports” were grouped in just one line.  

“Imports” came to equal the entire output of the Chrysler corporation; exceed all of American Motors; exceed all of the Lincoln-Mercury division of Ford, not to mention Pontiac, Buick, Oldsmobile and Cadillac.  Of the Big Three producers, only GM’s Chevrolet division and Ford Motor Company’s Ford division sold more cars than “imports.” 

Yet Detroit was guilty of automotive racism–they all looked the same.  Those "imports."

Over the years, Detroit management blamed the following: a “surprise” shift to small cars in the late ’70s; US tax policy; Japanese industrial policy; dumping; unemployment; US engineering education; a pro-Asian faddish cult of style in California; poor technology; labor costs; health care costs; pension costs; the UAW; suppliers; dealers; government regulation.

Not until the 1992 issue of Ward’s–when the US market share of “Imports” had passed 31% in 1988 and 1989–did the table break out “import” statistics to distinguish a Honda Civic from a Mercedes.

The self-description of an industry says a lot.  It declares to one and all, this is what we believe, and this is what you must know if you want to understand our industry.

Decisions about language and statistics quickly become self-reinforcing.  The more you see the data in a certain way, the more obvious it becomes that this must be reality.  In Detroit’s case, the belief was The Big 3 = the auto industry.

Swanson, the original “TV dinner” failed to capitalize on its advantage; a magazine explained,  “It was one thing to have missed the trend toward Thai; it was quite another to have missed Italian.”

Missing the relevance of “imports” for over 30 years qualifies as “missing Italian.”

There is no rescue for an endemic mindset like this.  It has to be broken up.  Incompetence on this scale and depth demands nothing less.  The suppliers and workers of the US auto industry are the victims here, but we cannot afford to use the sclerotic bureaucracies named GM, Ford, or Chrysler to be agents of rescue.

We really do need bold new thinking here: Obama’s economic team, are you listening?

In the spirit of trying to offer some breakthrough ideas, here are a few starters:

•    Give Toyota $10 billion to be used solely for hiring US workers and establishing a US auto industry de novo; limit repatriation of earnings for political palatability, but get someone running the industry who is not blinded.  

•  Sell the brands, re-hire the workers; blow up the companies, and (severely) retrain the execs for work outside the auto industry;

•    Bail out workers and retirees through massive infrastructure programs and assumption of pension liabilities. 

•    Build up Michigan tourism (as a former Michigander, I’ll testify to the State’s beauty and resources).

•    Ban from the industry anyone who used to have his name on his parking slot. 

•    Move marketing HQs to coastal locations like Miami or Los Angeles 

•    Require all marketing execs to speak at least two languages

I do not have the answers, but it’s going to take something this drastic. 

Trust destroyed this badly cannot be recovered by those who lost it.

 

 

The Etiquette of Selling

/0 Comments/in /by

There is such a thing as etiquette.  It isn’t just about Emily Post and table settings, either. 

Etiquette is the rules of the Game of Association Between People.  All people, everywhere. And while not all the rules are written, you violate them at your risk.

One of those rules is that intimacy has a pace and a sequence.  Some things are done only after other things, and usually with a certain elapsed time. 

I know you’re thinking of romantic relationships at this point, and that’s fine; it’s a pretty good case in point.  Some things you don’t say or do until other things are said or done.

We forget that exactly the same rules apply in sales.  Which is precisely the point made by Michael Holt, CEO of the design firm gardyneHOLT in Auckland, New Zealand in the following email he shared with me. 

Michael met a financial planner at an Expat Show in Shanghai.  He spoke for perhaps 15 seconds with the person—let’s call him Joe Planner–and exchanged business cards.  He later received a letter from Joe.  Here is Michael’s reaction:

Hello Joe Planner,

Thanks for your email and I did look at your site. Very comprehensive, although I must say, I am usually put off by obvious stock photography rather than real images of your firm, your people, your office, your clients.  I feel that stock images are trying to hide something.

However, in response to your email, you say that you "remember that we spoke about ways to help me save."  Umm… no we didn’t, Joe. I’m sure that your email is a form letter and you’ve just put it out to me along with many other people.  Do you think that you can build a relationship with me, in offering a customized and tailored service… by commencing with a form letter? Do you think I’ll feel that you’ve given me any more thought than entering me into your sales follow up database?

Can you think of something more critically important to me that my future financial well-being, and yet you want me to trust you with that when you have an incorrect recollection of our opening conversation?  Of course I understand that you’ll have met many people at that event, but why state then that you remember our topic of conversation when you don’t?

I feel that you are following up to a pile of received business cards, including mine, and you’re being a good sales guy by doing the numbers game work. That’s fine and perfectly normal… for a commoditized and process-driven business process.  Except of course, that I’m a person, and not a box.

As it happens, I have a complex set of financial arrangements centering around establishing branches of my firm in 2 countries overseas right now, and where I’ll be living with my family from next year.  All this amidst global financial insecurity.  I’m looking for a partner and advisor that treats me with respect, that asks more than it sells/tells and that doesn’t insult my intelligence with form letters.

Best of luck,

Michael Holt
CEO

Michael is simply voicing what we all know as customers.  There is a law of etiquette in sales. Some things you don’t say or do until other things are said or done.

Joe didn’t follow the law of etiquette in sales.  In return he received the predictable consequence–in this case voiced by Michael.

I think Michael said it pretty well.
(BTW, he tells me he didn’t hear back from Joe Planner.)  
 

Trust and Regulation

/2 Comments/in /by

Regulation is a social substitute for trust.

That’s not a moral statement, just a factual one.

Sometimes the relationship between trust and regulation is obvious We submit to the regulation of traffic laws because we can’t trust everyone will simultaneously interpret the rules of the road similarly. And, when stoplights fail, we trust the regulation of traffic cops, whose very jobs are the result of a citizenry’s decision to be regulated.

Another regulatory no-brainer would seem to be the “commons,” i.e. a situation where, at the margin, it’s in everyone’s personal best interest to behave selfishly. Except that, when everyone does so, everyone turns out the loser. (In game theory, the “prisoner’s dilemma” spells this out). We can’t trust everyone (or even most people) to do what’s socially good, so we submit to regulation.

So it is we end up with regulated airspace and water tablesthough there are still crazies who insist they should be able to fly anything anywhere anytime, and drill any water drillable beneath their half acre of Arizona; plus, we still over-fish.

Closely related are natural monopolies, e.g. utilities (except, bafflingly to me, water companies in the UK). These businesses left unregulated will drift, often quickly, to monopolies. Much of regulatory debate is how to balance society’s interest vs. the normal trappings of markets. (Can we trust Microsoft to innovate? Airlines to share route rights? Telecom companies to share scale economies?)

The right degree of regulation for natural monopolies would be an easy matter for industrial economists, if only political ideologues nattering about free markets vs. socialism would leave them alone.

Much less is clear when it comes to naturally competitive markets in which people and companies behave in an untrustworthy manner toward customers, shareholders, employees and society. Here the issues become more clearly trust-related.

Can we trust the stockbroker’s motives when he recommends a stock? The food company’s label of ‘organic?’ Can we trust that the insurance company will be there when it’s claim time? Can we trust that a corporate email sent in confidence will be treated as such? That a doctor’s prescription is not unduly influenced by a pharmaceutical company?

Here are a few social policy rules of thumb for thinking about the relationship between trust and regulation.

1. Trust—where possible—is preferable to regulation. It avoids moral hazard; it is cheaper; and it is specific to the situation at hand.

2. Industry associations have a potentially powerful role to play. Too often they see their role as defenders of their constituents against regulation, rather than the far more constructive and long-term perspective of evolving powerful self-regulation. (I have blogged on this topic before; for mortgage banking, see my blogpost here; ; for financial planning, see here. Or, simply look at the regulatory nightmare the pharmaceutical industry has become, largely by failure to self-regulate.)

3. Certain industrial economics criteria cry out for regulation. If no one—investor, regulator, customer—has an integrated interest across a sector of business, then the situation is rife for abuse. The securitized mortgage industry had no one with an integrated perspective.  Regulation becomes by default attractive in such cases.

4. All else equal, short-term perspectives destroy trust and invite regulation.

5. Transparency may be the least costly form of regulation. It works best when obvious  It works best when obvious: e.g., "smoking causes cancer," or "these assets were marked to market."  Transparency as "the fine print" loses its power quickly. 

6. If an industry is fond of saying things like “caveat emptor,” or “hey it’s not illegal,” or “we’re only giving the consumer what they want,” look out. This is defensive language, typically used against stakeholder complaints—Big Tobacco, Big Food, and, I suspect, melamine producers in China.

7. Personally, I think business-school faculty have a huge responsibility. In an increasingly hyper-linked world, the competition-centric ideology taught as “strategy” is increasingly dysfunctional. It destroys trust by teaching that the natural state of business is to compete against our suppliers and customers, rather than to collaborate with and serve them.

By destroying trust, it invites regulation. Which, as stated in point one above, is the less preferable of the two.

Business, heal thyself; it’s better for all.