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Bond ratings were far from the only trust-forming device that blew up.
The point of Yandle’s best-known paper on the topic is that this is the only financial crisis in our history that resulted from a collapse of trust. It wasn’t a failure of central bank policy, as in 1933, or a lack of liquidity in the market, as in the panics of the 19th century.
And once gone, trust takes a very long time to come back.
Transaction costs up
Yandle answered a question about the return of trust by telling a story about neighbors, when one leaves town and asks the other to please keep an eye on his house.
That works fine until the new big-screen TV goes missing and investigators later find it next door at the neighbors’. That’s a case where those neighbors could live side-by-side 20 more years, and trust never recovers.
The reason trust matters in a market economy is that lack of trust is a major factor in what are known as transaction costs. The money that goes to lawyers and regulators is one example, and so is the time people have to spend digging into the background of a person or firm on the other side of a proposed transaction.
Low transaction costs make markets far more efficient. Capital will flow more easily to the most promising opportunities.
Consumers will readily choose the goods they think best meet their needs and put their savings into investments rather than in a coffee can buried in the back yard. All of this spurs economic growth.
Yandle said there are signs of a recovery in trust, as the volatility in financial markets has settled down, retail sales have recovered and so have some lending markets.
On the other hand, he said, slow bank lending and the increased regulatory burdens on bankers are some signs that trust has a long way to go to fully recover.
“I knew it was serious,” he said, looking back to the fall of 2008. “I knew we were in trouble. But I had no idea we would still be mired in the effects of that collapse five years later.”
There aren’t many benefits that came out of the experience of 2008. About the only one that comes to mind is perhaps a bit of clarity.
If anyone wondered whether the people who run America’s biggest financial institutions deserved our complete trust, the events of 2008 should have settled that.
Of course they don’t.