The economics of trust

In this post, I'll explore interest rates with a focus on trust.

Earlier this year I was listening to the book-on-cd version of Alan Greenspan's Age of Turbulence. Greenspan's political views aside, it was an interesting biography which provides some important insight to a dabbler in economics.

One of the things mentioned by Greenspan was the importance of trust in a capitalist economy: Greenspan noted its importance multiple times, citing it as a reason for the problems with some of Russia's past failed attempts at capitalism. And, indeed, it seems that trust can be a useful lens through which to view much of our economy.

First, trust is behind any notion of financial credit (and the two are really synonymous): our own economy has been in dire straights recently because banks are less willing to lend to one another or to individuals. Normally this would drive interest rates up, if the government were not willing to subsidize the credit markets with its record-low federal funds rate. This subsidy of trust can sometimes do wonders to the system, with all sorts of second-order effects (these second-order effects include making safer investments less attractive, which leads investors to invest in more risky securities).

In addition, trust allows disparate groups to work together. Instead of spending economic resources competing, or spending these resources duplicating work, groups can turn attention to shared goals and exchange of legit promises.

Finally, trust improves personal responsibility, as individuals aim to improve their credibility in a system which rewards it.

Trust Bubbles

At other times, subsidized loans can inject too much trust into the economy, as happened originally when the interest rates were too low in the middle of the 2000-2010 decade. Here, market participants all over felt too much trust: mortgage lenders trusted that borrowers would pay back their loans (okay, sometimes this was not true). Both borrowers and lenders trusted that the houses being purchased would continue to be valuable. Once it was clear that these houses were not worth as much, owners began walking away. And those buying these mortgages from the lenders as mortgage-backed securities trusted that the mortgages were actually worth something.

Note that it's not clear whom these borrowers trusted -- there was a mutual trust shared by all market participants -- essentially a bubble. But none of this could have happened if people hadn't trusted one another so much. So how much trust is optimal? I'm not sure yet.

Trust in low-income populations

I'm convinced that improving trust can help certain low-income or historically oppressed populations in the U.S. improve their economic situation. Many of these populations have been found to have low interpersonal trust, and conspiracy theories are associated with lower income (these theories both feed off and encourage mistrust, although the object of this trust is unclear).

Perhaps there could be an effort to improve trust in these socioeconomic groups by subsidizing trust in them. We're already doing this to the larger economy with interest rates and with direct payments to other countries (take our subsidy of trust between the U.S. and Pakistan); it is only natural to improve trust in those parts of our population which need it most.

The advantages are clear: Sam will happily lend his paintbrush to Jonny next door because he knows Jonny will return it. Sam can trust that his neighbor Maggie will carefully watch his toddler while he's at work. And Maggie -- who still needs to support her family -- knows that Sam will pay her at the end of the month when he gets his paycheck. No need for Sam to waste money on payday loans. Jonny does not need to buy his own paintbrush. And Maggie's can make an income from watching Sam's kids. Everybody wins, because of shared trusts.

How can we provide these subsidies? Subsidized sub-prime lending has already been inadvertently tried and failed.

Here are some potential scenarios: the city offers low-income resident groups packages (i.e., money) up front to paint, clean, and maintain certain areas of the city. Once a project has been completed, a new package is offered. This would foster a better relationship between the city and residents, while also improving inter-resident relations and property values.

Another possibility: the city can help property owners to offer financial "options", or a share of any increase in home value, to renters. With an actual stake in the value of their homes, renters will have a clear incentive to improve and maintain their homes. Renter-tenant trust increases with the shared incentive.

Finally, a trust campaign might help. With modest funds from the city's stimulus money, the city can offer an advertising campaign, encouraging residents to trust one another.

These possibilities may or may not work. But if we are able to discern and define exactly the trust we should aim to improve, there must exist an appropriate subsidy.

Finally, the economic importance of trust extends to the city government. Only when the city has demonstrated that its interests lie first and foremost with Saginaw residents will the residents trust the city. And when they trust the city, everyone wins.

(This post is a bit scattered as-is. I may submit some polished version of this to the Saginaw News)