Michael Mainelli: If only the banks had trusted each other, we might all be better off

Today's financial crisis is, at heart, a crisis of trust. A few years ago, banks knew how badly they managed their own risks, how aggressively they had priced their own assets, and how much their own bonuses depended on these aggressive valuations. "If we are acting so irresponsibly, think how much more irresponsibly other banks must be acting," they thought. Thus, when repricing started, projections of social norms indicated that the repricing and credit terms should be more negative than market norms indicated. The banks failed to trust each other.

The general consensus is that a high-trust society is a preferable place to live and probably more efficient and effective. However, that does not mean that trust is an unmitigated good, nor that we shouldn't retain some mistrust. If you could imagine a "no fraud" Britain, you could equally imagine a national of gullible folk. What we want is rising levels of trust without losing basic levels of suspicion.

In a high-trust society, competition may not work effectively in keeping self-interest in check. In a low-trust society, constant checking wastes resources, whether it is because people are being ripped off by one another, or the Government has created a low-trust society by taking resources through inflation, resulting in wasteful anti-inflationary planning. Commerce is about people and trust, not just money. Low-trust, high-value transactions are almost wholly criminal. Equally, we will always have large numbers of low-trust and low-value transactions. When society functions well, we have large numbers of high-trust and low-value transactions being conducted efficiently, like newspapers or prescriptions. When times are good, we have quite a few high-trust and high-value transactions, like long-term construction contracts, that are precisely the transactions to suffer most when society as a whole is leaking trust. At the end of the day, we must decide whether commerce corrodes or enhances trust.

For me, commercial self-interest ensures that successful commercial people must maintain a basic level of trustworthiness, while competition ensures that basic trust levels increase over time. Or am I just too trusting?

From a lecture this week by Michael Mainelli, Professor of Commerce at Gresham College in Holborn, London