We Had A Trust Bubble

Forget housing, real estate, Wall Street, derivatives, CDOs, CDSs and all that jazz for a moment.

The real nut of the financial crisis is that we had a bubble in trust. Everyone had too much trust in their fellow humans and organisations, and for a while that was tremendously profitable.

A no-doc loan is a shining example of something that could only exist in a trust bubble. The outsourcing of risk management to a ratings agency, or an unproven algorithm, even when the conclusions defied common sense, are also examples. We could go on, but you get the point: All kinds of brands and third party arbiters, who used trust as the core of their business model have been exposed as being naked and dishonest, and now we’re paying the price for having been so naive.

Along these linesĀ  Alex Tabarrok points to an paper (.pdf) showing a (fairly intuitive) correlation between societal distrust and regulation. Namely, in societies where distrust is more widespread, there’s more government regulation. That makes sense. If you and I can’t trust each other, we’re more likely to need an official arbiter setting more strict rules on commerce.

This chart, for example, plots regulation of the minimum wage against measured distrust.


Again, kind of obvious. But the paper goes beyond drawing the correlation, and this is the part that we think is most interesting.

Tabarrok explains:

Crucially, when people distrust others they invest not in the highest return projects but in human and physical capital that is complementary to distrust–for example, they invest in human capital that helps them bond with their group/tribe/family rather than in human capital that helps them to bond with “outsiders” and they invest in physical capital that is more difficult to expropriate rather than in easier to expropriate capital, even though in both cases the latter investments may be the all-else-equal higher return investments.

Are you already seeing this in our post-trust bubble economy? You bet.

You’ve no doubt read an unending series of NYT Style stories about the rise of localism. Local foods. Local goods. Homegrown. Handmade. It’s all very big, and it’s the logical response to a society that had grown too trusting of outsiders. Now, people want to know who butchered their steak, and they’re willing to pay more for it. More folks are discovering the joys of building something with their hands, even if “knowledge” work has the potential to be more profitable.

What seems likely is that we’ll end up overshooting, like all assets on a downswing. For some time, we’ll probably be too aggressive about shunning “trusted” brands and private agencies/third parties that can help us do various forms of due diligence, which does allow commerce to run more efficiently. We can’t all be experts in areas we conduct commerce; we need trusted third parties, and eventually they’ll be back. But for now, they’re still on heading down, so a trend towards local and physical and regulated will probably continue for some time.

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