In the past decade, the word “Davos” has come to symbolize the annual jamboree of the rich and powerful. Chief executives power schmooze with powerful politicians and get work done informally, away from enquiring gazes. By all counts, envy (of the have-nots and those left behind) was held to be the emotion behind such descriptions.
Guess what, there is another emotion at play in that Alpine setting, raised by none other than the participants at that annual fair themselves: Trust, or more accurately what to do with the near total wiping out of trust in Western financial markets. One interesting document to come out of this process of rethinking is the so-called Trust Meltdown report edited by Roland Schatz and Matthias Vollbracht. It goes into the reasons behind this loss of trust and what to do about it.
In any economy, trust is the lubricant that oils markets. Formal, easy-to-enforce contracts go a long way in carrying out transactions. But they are hardly anything in the absence of trust. Imagine if there were to be a contract for everything: Markets would grind to a halt, the cost of such contracts would ensure that profits would disappear and transactions would seize. Lenders would sit on their pile of money and borrowers would be starved for cash. Something similar happened during the 2008-09 financial crisis.
The report argued that the opaque functioning of these markets, coupled with the use of information as a strategic tool, at times to mislead investors, went a long way in creating a mess. The use of exotic securities whose pricing was closer to the throw of a die, the freezing of credit markets and the anger over huge bonus payments to financial industry executives were all part of this mix of opaqueness and loss of trust.
The authors come down heavily on these executives. Their arrogance and inability to say a simple sorry to their investors and those who lost money made matters worse. If the analysis appears to be right, the remedies suggested by the authors seem a bit quixotic. They favour better communication, participation by senior executives in “public discourse”, admitting mistakes and making appropriate changes at work, among other measures. On their own, such steps can only be palliatives or can be systematically misused again. In the absence of regulation and punitive action, these steps won’t work.
How can trust be restored in financial markets? Tell us at firstname.lastname@example.org