A Matter of Trust

Much of the recent hullabaloo about the “credit crunch” and “sub prime crisis” is emotionally satisfying. The stockbrokers, hedge fund managers, and other grey pinstripe suit hucksters with six figure gas guzzlers who got us into this mess have a healthy air of panic about them and a salubrious paranoia born out of wondering when the next crisis will emerge. If one were to use Tom Wolfe’s “Bonfire of the Vanities” nomenclature, it could be said that “The Masters of the Universe” are finding their constellations collapsed, and the “Big Swinging Dicks” have shrivelled like they’ve been blasted by an Arctic chill.

Bravo! If we must go through a recession, at least the majority get generous dose of schadenfreude, the in-flight movie on the swan dive to hell.

That said, it’s not an unreasonable assumption that they’ll be back: after all, the Great Depression, the Savings and Loans problems in the 1980’s, dubious loans to Russia in the 1990’s and the Dot Com bubble failed to destroy them. However, the present period of the hairshirt and chastisement may last longer than the titans of finance care to admit.

For most of us, banks are simply a fact of life; something that is necessary, evil or both. Their initial reason for existence has been obscured by finance’s present-day Byzantine complexity.

Banking’s raison d’etre can be summarised in a single word: trust. First, individuals trusted banks to store gold and keep it safe: this was a much better prospect than keeping it hidden under a mattress or in a strongbox.

Later, individuals trusted that bits of paper issued by banks were backed by sufficient gold to take on the role of currency. Later still, investors trusted banks to make prudent investments and get a return on the cash they had stored with them. Individuals and enterprises also trusted banks to have sufficient assets to provide loans. None of these innovations are recent: these assumptions have been in force since the Italian Renaissance.

What is most remarkable about today’s crisis is how quickly this ancient trust has been undermined. People no longer believe their savings are safe: for example, Britain recently experienced its first bank run in over two hundred years. Banks simply don’t know if their investments are prudent: modern financial instruments are so complex and opaque that no one truly understands how thoroughly sub-prime assets have infected the blood flow of liquidity. Individuals and enterprises don’t trust financial institutions to have sufficient assets to provide or take on loans.

To put it in Shakespeare’s parlance, the result is a “reeling world”. It’s gotten so bad that, quietly, the central banks have replaced the invisible hand: they have instigated large-scale lending to private institutions, thus providing the “trust” that the free market can no longer supply. Will this work? Maybe. In recent weeks, the Masters of the Universe have occasionally indicated that their planets will again spin in predictable orbits: there have been brief stock price rallies. So far, these gains have proven temporary.

However, if we are lucky, the present instability will be the last straw. Re-regulation is the watchword; it’s clear that much more responsibility will be taken on by government for what happens in the financial markets: the “Big Swinging Dicks” may be constrained by a chastity belt before they screw anything else over. If so, we should be glad: a more predictable, if sedate world, is worth obtaining, even if it means we’re no longer entertained by brokers on the edge of a nervous breakdown.

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