Monday, October 06, 2008

A failure of trust

James K. Galbraith:

On the morning that Lehman Bros. and Merrill Lynch fell,... the ... Dow Jones average fell 504 points... As stocks crashed, suddenly people remembered that modern markets cannot exist without a cop on the beat. Every important market out there, from fresh food and safe drugs to autos and air travel to housing and health care, depends on government to maintain trust, and without it, none of them would survive. Without regulation, predators take over, and when they do, trust eventually collapses. Every important market is in peril now, precisely because of the predators in power these past eight years. And none more immediately than finance.

Trust is the key word here. Without it, nothing which depends on the transfer of value between parties can ever function. Because if the parties involved in the transfer cannot trust that what they are paying is a fair reflection of the value of what they buying then they will just stop buying. The more trust breaks down, the more trade breaks down, until the only markets that operate are those that deal in the most essential goods (and those are sold at highly inflated prices).

Those who scoff at the idea that markets break down when you deregulate them focus to much on the question of direct cause and effect. If you can't identify the specific thing that deregulation caused that will lead to a breakdown then deregulation cannot be blamed for the breakdown.

But the breakdown is systemic. It isn't in a single type of transaction. It is a breakdown in the overall system of trust that is necessary for any market to function. And the cop on the beat, as Mr. Galbrath describes the government, provides an essential role in shoring up that sense of trust. People trust in the value of what they are buying because they trust that the cop on the beat will do what he can to make sure the crooks and charlatans won't get a dominating position in the market.

When that trust breaks down, it is very hard to get it back. That is why, I believe, that the $700 billion bailout, even if it was necessary, will not be sufficient to restore trust.

Now I believe that people want to trust the market. They want to get back into the flow of things because just hunkering down is a position that few can maintain for very long. So getting that trust back is really just a matter of effort. Cracking a few heads (figuratively). Establishing new stories of trust fulfilled. All of these things can entice people to come out of their shells and start working the markets again.

This will happen, regardless of government action. But if it isn't the government who does it then it will be a government like force that will arise within the market itself. Unfortunately, that kind of force is often of a more unsavory variety (its how organized crime can get a foothold).

So the question for us is not whether the trust will return. The question is who will return it and what will be the cost?


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