Trusted Transactions, or Trusted Relationships?

Justice Potter Stewart once remarked, with respect to pornography, that it was virtually impossible to define it, but, "I know it when I see it."

Ditto for trust. It’s both a verb and a noun. Its objects are implied and contextual, as in "I trust my dog with my life–but not with my ham sandwich."

Increasingly, we need to make explicit another dual-meaning of trust. We trust relationships, and we trust transactions.  I trust John—to have my best interests at heart. I trust eBay—to create trustworthy transactions with strangers. It does not follow that I trust an eBay customer to go out on a date with my daughter.

Much of the public dialogue today confuses these two distinctions. Is it Congress that people don’t trust? Or is it members of Congress who themselves are considered untrustworthy? To the average voter, it’s a distinction without a difference. I suspect the inability to tease them apart is itself a source of anger. But if we fail to separate them, we doom ourselves not only to nasty public discourse, but to failed solutions.

Trusted Relationships in the Mortgage Business.

In 1970, the US mortgage industry was still adequately described by the perennial Frank Capra Christmas movie “It’s a Wonderful Life,” with Jimmy Stewart as George Bailey, president of the Bedford Falls Savings & Loan. Bailey (for he and the company were inseparable) made loans to people he knew personally.

The bank’s depositors were Bailey’s friends and neighbors. The depositors were also the borrowers; likewise, the employees. The loans stayed on the S&L’s books, presumably to term. Those who took out mortgages had no intention of doing anything other than paying them off, with burn-the-mortgage parties at the end.  No moral hazard here.

This was relationship trust. The strength lay in personal ties, cemented over time. A man’s word was his bond, and anyway you knew where he lived. His reputation was everything, at least until it wasn’t. Relationship trust served business and society well.

But relationship trust was about the only kind we had, and it had its limits.

Transactional trust in George Bailey’s world was shallow and fragile indeed. The S&L was at risk of being forced out of business by a single competitor, the evil Mr. Potter. It was at risk of the low-tech deposit processes of Uncle Billy. Most importantly, it was at risk of a bank run. It was a good thing George Bailey worked the relationship trust game well, for he had precious little else to depend on.

Trusted Transactions in the Mortgage Business.

In 1995, Dwight Crane, Robert C. Merton and others published The Global Financial System: a Functional Perspective. A masterpiece of what sociologists knew as “functionalism,” this book laid out the case for transactional trust, viewing the mortgage business as one part of a complex and, ideally, integrated financial system.

In the chapter on mortgages, they ran down the characteristics of a system you could trust. It would have markets—markets for deposits, markets for mortgages, markets for loan originations. The book listed the costs of not having a systemically integrated system: risk of meltdowns, differential pricing within very narrow geographic regions, low liquidity, gross inefficiencies.

In short, George Bailey’s relationship-driven-trust was too risky, too costly, too uncreative and too unresponsive. Above all, it was too expensive. Consumers–the would-be purchasers of mortgages—were subjected to higher prices than necessary, driving up the cost of home ownership, and therefore driving down the economic livelihood of those seeking the American dream. 

You simply could not trust such a system, the good professors opined.  “It’s a Wonderful Life” was now half a century old. George Bailey was quaint. No one noticed that only one year before the 1995 book, contributor Robert C. Merton became a Board Member of a little hedge fund called Long-Term Capital Management L.P.  

In business, Progress was synonymous with all these terms: systemic, low-cost, efficient, market-based, liquidity. No one was about to cast doubt on the important and positive nature of all these terms.  The academics and wunderkind of Wall Street were creating institutions you could trust.

The new trust was almost entirely cast in terms of systems and transactions. Transactions replaced relationships. Where markets couldn’t handle the job, models could.

In a few short decades, the “trust” pendulum swung from a man’s word to the solidity of a system. We went from high personal trust to high systemic trust–each extreme without the moderating influence of the other.

We Need Rich Trust.

The transactional revolution in mortgage banking indeed delivered on most of its systemic promises. Markets were established, costs were lowered, liquidity was raised. But it all, as we know, ended very badly.

The confusion over trust went way beyond semantic. Alan Greenspan himself in 2008 famously said:

"I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms."

In other words, Greenspan thought that transactional trust would have the same sort of reputational bias that relationship trust had. He was, sadly for all of us, mistaken. 

Transactional trust absent relationship trust had its own internal seeds of destruction. The absence of long-term relationships was crystallized in the Wall Street acronym IBGYBG—I’ll be gone, you’ll be gone, let’s do the deal. Just as personal trust doesn’t scale easily, so transactional trust doesn’t easily foster ethical behavior.  

George Bailey wasn’t wrong, he just had no system. The professors weren’t wrong, they just assumed relationships. The truth is: we can’t afford just one form of trust or another, we need a rich mixture of both.

Well Beyond Mortgages.

The mortgage industry is but one example. As recently described in a New Yorker article on the US Senate’s inability to develop energy legislation, the political process has become as ugly and dysfunctional as anything involving collateralized mortgages. Lifetime politicians are continually compromising principles and relationships for another shot at enhancing their power.

Yet they are not wholly to blame. They are caught up in a system which insists on money and soundbites, with ever shortening cycles of time. The press, caught in its own compressed cycle, competes with reality TV and blogs to capture the public’s insatiable desire for more intensity, faster. The Shirley Sherrod case—a grievous rush to judgment for the sake of ratings—dramatically showed how compromised the press has become. And another case—a Bloomberg news reporter’s bizarre attack on Prudential—shows how blasé we’ve become about it.

And the electorate, reflecting it all, ends up exerting single-issue us-vs-them pressure on its own.


The polls are basically right: we do have a crisis of trust. But what crisis? It is not just a failure of morality. We cannot fix it solely by getting back to ‘family values,’ or seeking out leaders of impeccable morality. Those are, in fact, necessary conditions, but they’re not sufficient.

On the other hand, those who insist that the system is sound, it just needs tweaking, are dead wrong as well. This is not a matter of incentives needing adjustment. This is not a matter solely of transparency in markets. Those too are necessary conditions—but not sufficient.

We live in an interconnected world: transactional trust is critical for us to do live a life built on global commerce without it. 

At the same time, there is no social structure or business process that can work without humans. There is no lock that can’t be picked, no code that can’t be broken. There is no inhuman system that can’t be perverted by humans. 

Trusted transactions? Or trusted relationships? Yes. We need ‘em both.   

8 replies
  1. peter vajda
    peter vajda says:

    “The polls are basically right: we do have a crisis of trust. But what crisis? It is not just a failure of morality. We cannot fix it solely by getting back to ‘family values or seeking out leaders of impeccable morality.”

    I’m taking this out of context, Charlie, as I have another perspective.  My take is this notion of “family values” is not so much about “morality” (a man-made construct) as it is about something you alluded to in  your previous post about convincing your boss – and that is, “why can’t you think (be) more like me?” To me, it is about high self-orientation and that the universe revolves around me – and my way of thinking, believing and what’s “moral.” If many of those referred to in these polls had their way, and once everyone who didn’t  “think like me” were shipped off to another plant, well there might be three or four folks left on Mother Earth….and only until those three or four were at loggerheads with one another.

    Trust, for me, leads to inclusivity – whether it’s a matter of trust in transactions or trust in relationships. The polls IMHO are more a function of hate/fear which augur against trust and even against so-called “morality.” “Whose morality (so-called values)  is it anyway?” If it weren’t for the billions of those "other" humans on the planet, life wold be grand! That’s the message of such polls and to me that’s a message of high self-orientation and very low trust.

    Just an aside but it jumped out at me.


  2. Barbara Garabedian
    Barbara Garabedian says:

    Peter, I do so enjoy your reactions…to copy a chapter from Charlie’s book, how’s this   formula sit w/ you. SFIt : S (high self orientation) + F (high fear of the unknown) = I (high intolerance) and t (very low trust capability)  

  3. peter vajda
    peter vajda says:

    Works for me, Barbara.

    My take is that’s it’s not so much about (high) self-orientation as it is (and Charlie speaks about this often in various ways-bless his soul), what’s underneath (driving) one’s high degree of self-orientation. 99.9% of the time it points back to fear and "fear of who or what?" is the requisite Inquiry that can bring one (if one is ready, willing and able to sit with such deeper self-exploration) to see that it’s never about "it, him, her or ‘them’," as it is about "me."  More’s the pity that so few are able or willing to embark on, or even consider, such a journey. So, in that void, we get what we deserve – lots of "I"s (in your formula) manifested in in its myriad shapes and forms, including polls.

  4. Barbara Garabedian
    Barbara Garabedian says:

    Well put Peter.

    Fear has been the major disenabler and enabler throughout history.  Royalty/religion/despots/countries have used fear to muster "the troops" to die  for "the cause" against the great— (fill in the blank) menace for centuries. Fear has also paralyzed millions to sit back and watch  immoral/dishonest/ unethical activities without raising a finger to protest.

    If fear can generate such "uncivilized" behavior, isn’t it interesting that so many are surprised to learn that high self orientation leads people to  behave in a manner that’s basically a  "civilized" knee-jerk reaction to fear.


  5. Rich Sternhell
    Rich Sternhell says:

    Peter and Barbara….thanks for a wonderful exchange of thoughts…fear of "the other", whatever that is to whomever is fearful had been used by those wishing to manipulate groups they want to control throughout history.  We are certainly seeing it today.


    I never get tired of the George Bailey analogy…maybe because I liked the movie.  It is interesting that Sarbanes Oxley is all about our inability to trust relationships.  The law requires controls be in place throughout the organization and for the CEO and CFO to certify that those controls are in place and that they are working.  When you look at the level of controls required (e.g., how cash application is handled), it is obvious that the CEO and CFO can not possibly know how those controls work or whether they work.  As a result, organizations require expanding layers of management to sign sub certifications or attestations as to the effectiveness of controls.  Thus we have a law in place designed to give investors trust in a company’s financial statements but the real outcome is that management can now rely on a signed document rather than actually knowing the process.  In spite of all the rules in place, banks have created a foreclosure mess by cutting every process corner they could find.  They then argue that it really doesn’t matter if they didn’t follow the rules, people owed them money.  Nullifying a fair number of these mortgages might send a message that rules apply both ways.  If we are going to build a business environment based on rules and processes rather than relationships…we have to enforce the rules and processes ruthlessly.

  6. peter vajda
    peter vajda says:


    Reading your comment reminded me of something I recently read, and the gist was that (government) "regulations" are created when folks within an industry cannot or will not hold one another accountable to be integrity, follow industry standards and principles, be honest, be trustworthy, behave in ways that are above board and the like. That’s the purpose of regulations.

    It just dawned on me the incredible hue and cry by many against federal regulations is tantamount to wanting to make trust almost illegal. Maybe this is a no-brainer for most, but I never thought of it exactly that way. Trust is a nuisance. Trusting and trustworthy relationships are an irritant and just get in the way of conducting business, etc., etc.  Hmmm.

  7. Rich Sternhell
    Rich Sternhell says:


    You’ve hit the nail on the head.  Regulations emerge from failures of trust….but at the same time make trust irrelevant.  One would think that industry would want more regulation as it would obviate the need for them to be trustworthy.  An interesting conundrum isn’t it.





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