Trust - Not Confidence - Is the Issue for Geithner

Trust is the underlying issue for economic recovery, not confidence. Various packages proposed or underway in the U.S. and other nations are intended to boost consumer confidence. But, despite efforts in the financial sector, the gap in trust may be widening. And new Treasury Secretary Geithner may be prising it further open.

In economics, consumer confidence means the expectations that consumers have about the future performance of the economy. More confidence and higher expectations boosts consumer spending, which stimulates producer investment and bank lending. Hence, the various stimuli proposed or underway across the globe. The reason they may not work stems from the trust issue. Trust in economics means reliance on a party to fulfil their obligations. This ranges all the way from a simple exchange of a coin for candy to complex financial deals, where each party has a range of obligations and exposures to a number of counter-parties.

But from the corner store to the financial boardrooms, no trust means no deal. Governments and central banks around the world are supporting banks, and flooding them with liquidity. This reduces counter-party risk and thus supports inter-bank trust and helps re-build bank lending. But behind this, a mountain of mistrust remains.

Let me count the ways:

Policy settings of central banks: The job of central banks is to deliver a stable monetary platform for economic transactions. So, can we trust them to deliver? The bubble was fed by monetary policy which focussed on controlling a narrow measure of inflation and countering any sign of a downturn. Such an approach, with its inherent asymmetry, can no longer be trusted. Central banks are busy countering the present crisis and let us wish them well. But beyond that, they now have no reference point for their policy. Only the most rabid Keynesian would maintain tax-spend-and-print as alternative long term settings. What we thought we could trust has gone, with no sign of a replacement. Both Benanke and Geithner "grew up" under the old doctrine at the Fed.

Expertise and professionalism in financial markets. The job of financial markets is to provide low cost intermediation; the job of financial institutions is to serve their clients, their shareholders and - in the case of banks - their counter-parties (other banks). No need to ask whether we trust them anymore to deliver. The only positive aspect is that government actions internationally have reduced counter-party risk. If they hadn't, we would be facing calamity. Whatever the mixture of greed, incompetence and bad-luck, the aura of professionalism over Wall St and the City of London has gone. The implosion of jobs will take out many of the best as well as the worst people. Expertise in the new world will be slow to build; so will trust. Geithner, inevitably, is close to the old guard, as was his predecessor.

Government's role in financial markets. Government's job used to be seen as light handed regulation and monitoring, with the occasional hand on the tiller or well judged intervention to keep things tidy. Well, that didn't work so now government's job is much bigger – heavy handed regulation, oversight, and ownership with plenty of interventions expected. Do we trust them? Well, political enthusiasms lay behind the propulsion of Fannie Mae and Freddie Mac (and before that the S&Ls) into agents of destruction, and political pressures prevented earlier problems with those bodies being dealt with in a timely fashion. In terms of monitoring by government agencies, we all know the Madoff story. And now political pressure is on for banks to worry less about their balance sheets and more about helping loan defaulters and keeping housing prices up. So, service as normal. Maybe Geithner can do better but so far the only evidence is to the contrary.

Debt and credit. Creditors (including buyers of debt instruments) need to be able to trust debtors and sellers of debt. Over-leveraging by banks and households and international distribution of toxic debt brought on the crisis. To prevent mayhem, governments are taking on much of the bad debt themselves by various means. So, the risk and the need for trustworthiness are shifted to them. The trust in government that is required by taxpayers (who will have to meet the costs of extra debt incurred by government) and by creditors rises as government debt rises. At one point will a trust deficit set in? Geithner and Obama seem keen to hasten a show-down with China. It's a tricky, two dependency between the U.S. and China. But, ultimately, "the borrower is servant to the lender" (Proverbs 22:7).

Government expenditure. In relation to households and the productive sector, the job of government is to provide a robust framework for doing business and undertake expenditure where households or producers are less well placed to do so, or to meet broad social goals. Let's be generous and assume that hitherto government has been pretty good on this. But now governments have taken on two new tasks: not only rescuing the financial sector, but also compensating for the downturn in consumer and producer expenditure triggered by the crisis. As I've argued elsewhere, the increase in saving and consequent downshift in consumption is likely to be both big and long term. So, the role of government in filling in for lack of consumption will likely be long lasting too (as in Japan). There will be a long term increase in government expenditure as a percentage of GDP.

This exacerbates the debt problem above but also raises the question of how far government is trustworthy in substituting for lost consumption – stepping in for households and producers in the marketplace. To the extent they are not, their activities and debt raising needs may crowd out the private sector and reduce consumption further as households save more to counterbalance government profligacy.

So, five questions – four of which relate to central institutions:

• On monetary policy, do central banks know what they are doing beyond monetary easing?
• On financial markets, do we think the private sector can recover and become effective?
• On government's role in financial market, do we think government can fulfil its greatly enlarged role effectively?
• On debtors and creditors, do we think the government can convince creditor and taxpayers about the huge debt risks it is taking on?
• On expenditure, do we think government can do a better job of spending than households and the productive sector?

The present crisis will be resolved satisfactorily if there are high trust responses to all those questions and those high trust responses turn out to be correct. If there is substantial lack of trust in just one of these areas, then the recovery will be much more difficult – even if the high trust response would have been correct. That is because, as I said earlier, no trust means no deal. Central government has considerable powers of coercion and compulsion domestically. But government actions will be gravely undermined if there is lack of trust. That's what ruling with consent means. And with foreign creditors, even the U.S. government lacks powers of coercion. It can only rely on the U.S. dollar remaining the least bad option.

Comments

[ROLEX18K:]

The geithner's face reminds me faces from the movies with cheaters and low level criminals, he looks like a lair who stole some stuff from Wal Mart and after being catched with pockets full of stolen goods, tries to persuade the cops that he done nothing wrong and it is a set up, then tries to bribe the cops.
For me is very clear, he is corrupted crook who will think from the first day on the work "damn America, I am here to make money for me and my cronies,the time is short, I will steal as much as I can from American taxpayers, help my bankers friends so then I will be out of job in 4 years, they will at least offer me a warm seat on the board of major financial institution.This crash is real, nothing can be done to save it and I don't care, only me and only my money, good obama is so stupid took me for this job with my reputation of thiev, but as obama will be no more than 4 years, we will both steal enough as American people are very naive,HAHAHA"

Jan 23 06:53 AM

[Geoffrey Mo...:]

While I can’t compete with ROLEX18K’s assessment of the situation, Simon I think you are right and that the trust issue is global.

The simple rule with trust is “the deeper you see the more you trust”.
So I come back to Joseph Stiglitz's remarks on Fareed Zakaria’s CNN GPS show on 28 December 2008:

“Much of the innovation that we've had in the financial sector in the last two decades has been of negative value. It has been creating complexity.

“It's not a question of disclosure. You could disclose these documents, but nobody -- the buyer, the seller, the regulators can understand them.

“And it was done deliberately. It was done deliberately, so people couldn't understand what was going on.”

Hernando de Soto added:

“You're starting to find out that the real economy has a lot to do with trust, more than with the so-called fundamentals. That when people are not able to identify each other, when they don't know what rights they have over what property or liabilities, then you don't get cooperation.

“The reason you are in paralysis, the reason you are collapsing, is because you no longer know who's got whose hand in whose pockets. Remember that financing is there at the service of production, in combination, and is not center stage.”

Jan 23 08:14 AM

[tdillian:]

to the author:

frankly, it is not only an issue of trust, is an issue of confidence as well. Most americans may not understand the details of CDOs, etc..

but to do know when someone has been given a free pass that they themselves would not have been given, and they also know when someone has lied.

Mr. Geither uses Turbo Tax, according to his own testimony, and LIED about not paying his taxes for 4 years.. and BTW: turbo tax is honest enough to tell the customer when they have done something wrong.. it takes human intervention to fudge numbers.

Lets hope Me. Geither uses Turbo Tax to do the nation's taxes, b/c it is obvious Geither cannot tell the truth.

So, the trust is an huge issue, b/c it is obvious the US governments new head of the IRS is lying about fudging his own taxes, and confidence is huge issue b/c confidence only comes when you can trust the person.

On both counts, trust and confidence, Tim Geither has HUGE issues.

Obama is too ignorant to know how ignoratant Tim Geither is, The clueless leading the blind.. hmmm..

Jan 23 08:17 AM

[prudentinve...:]

I was listening to an accounting professor on NPR who stated that Geithner, like all US emplyees, had signed a statement when he was hired by the international bank that said (a) the international bank was going to add SS taxes to his agreed pay, and (b) he was going to pay these taxes directly to US treasury. So, if this is true, it was not that he forgot to pay taxes, but rather that he kept for himself money that the international bank specifically gave him to transmit to the treasury. Lawyers would call this "conversion", as a polite euphemism for theft.

Jan 23 08:22 AM

[Top Gun:]

I agree with all above. We need a Treasury Sec who has public service as his sole purpose. Someone like Volker. Too bad only high profile people get consideration.

Jan 23 09:15 AM

[know nothing:]

Mcgoyavich,pay to play.. Just wait, the media will get tired of the pay to play program that Obama is a part of, then the media will expose the real agenda of this group. Trust and CONfidence is only but a dream! These politicians don't get it, they are appointing bigger crooks to office, than the last crooks that just left office. Oh,by the way, anyone paying attention to the gold market this week? Looks like the bugs are comming out of the wood work! What a nice sight to see! Gold will continue to benefit from the lack of trust, as I said yesterday, the fed running out of ammo,0% interest, failing banks, WHO wants to hold dollars? Buy gold for a safe haven and to secure your future.. We are along way from being out of the woods!

Jan 23 09:16 AM

[kelm:]

An excellent article. The global trust and confidence issues will only get greater. At the moment it seems the only person American's really trust is Obama and it's difficult to see how that can make up for the lack of trust in banks, the Fed etc. That lack of trust is going to hit the dollar in ways that few have thought through yet. We should not assume that we retain the worlds trust in our currency forever.

Jan 23 09:42 AM

[notsosmart:]

trust?what fool would trust this country after it papered the world with highly complicated phony rated AAA wortless paper? the pollsters should ask a staightforward question of all usa citizens"do you trust our gov? doyou trust the figures the gov gives you on anything? soon the census will be taken. these questions should be on them.never happen.

Jan 23 10:18 AM

[BK GUY:]

Trust, honor, responsibility, integrity, confidence. These are all disappearing, and our government is largely to blame.

If Integrity is doing the right thing when NO ONE is watching, it is readily apparent that Geithner has none. So why are we still discussing him for the second or third most important job in America right now?

Jan 23 11:01 AM

[Moon Kil Woong:]

No one could be more corrupt than Paulson. Thayt being said, no one who cheats on taxes should have this position. He should voluntarily step down to save Obama some face.

Jan 23 11:58 AM

[Socialism c...:]

The problem is government. It thinks it knows best how to use OUR money. It must get its hands out of our pockets and let US decide where we need to put it...whether it be mortgage payments or paying down credit card debt, etc. The problem is not just excessive taxation...but the MODE of taxation. Confiscatory taxation is preventing We The People from having control over our own earnings. Property taxes have become an abomination -- now up to 1/3 of a monthly mortgage payment in many areas. Is it any wonder mortgages are defaulting?

We NEED to move to another means of funding government at all levels: one that gives the earner the preemptive right to his money. And that by definition means a consumptive tax system. Please see fairtax.org for one such proposal.

Jan 23 12:08 PM

[Jake Berzon:]

And who can you trust these days? Can't trust politicians (i.e. Blagojevich). Can't trust money managers (i.e. Madoff). Can't trust banks (i.e. Lehman Brothers) and now, you can't even trust insurance companies that hold bank debt, which they pretty much all do!

Jan 23 12:10 PM

[Socialism c...:]

Geithner must go...NOW!! Aside from the core economic causes of this current crisis, the moral component has become quite pronounced:

1) Hedge fund scams (Madoff, Blencker, etc. -- yes, there were several, not just Bernie).
2) Government mismanagement of TARP (against the apprehensions of the People to begin with!!)
3) Conflicts of interest and past history of those involved in TARP:
a) Barney Frank, Chris Dodd, Obama, etc, -- who helped CREATE this mess by pushing subprime lending under the CRA)
b) Paulson's ties to Goldman Sachs and the seemingly "random" decisions on which banks survive or not

and now:
4) A new Treasury Secretary who seemingly is not financially savvy enough to know he must pay FICA on earnings for which it was not withheld by his employer??? C'mon -- that is not ignorance!! The man worked it. There CAN BE NO RECOVERY until we can trust the integrity of the leadership!!!

Jan 23 12:13 PM

[bobbobwhite:]

When a standing prez can put a purposeful lier and cheater in office, it has to be intentionally done. No honorable man would do that without considering who the public would approve of and what is right and best for America. But, that kind of honor has fallen way out favor in the new distorted America, where the sheeple continue to allow malfeasance and oversight in office for everyone, unless it's sexual. Then, look out! OMG!

We Americans have turned into such pathetic and stupid wimps and losers, as we get so upset at sexual dalliances but don't even get outraged enough to protest or do anything substantive when elected or business people steal trillions from us. It's beyond contempt.

Jan 23 12:55 PM

[the ilster:]

Yeah this is ridiculous but not really when you consider he is part of the private banking cartel that runs the central bank. He is a total insider and should not be trusted. Once again Bankers prove why they are more powerful than presidents. Get ready for the stock market to tumble another 20% before the end of the 1st qtr. Short IYR

Jan 23 08:41 PM

[Yohei:]

I think the American public's "trust and confidence" in Mr. Obama is wildly misplaced. We shall see how long this "trust and confidence" lasts, won't we?

Jan 23 09:12 PM

[diogeron:]

This is not a serious analysis. It's like me saying that Bush reminds me of a monkey, which he does. By the way, what is a "lair" anyway?


On Jan 23 06:53 AM ROLEX18K wrote:

> The geithner's face reminds me faces from the movies with cheaters
> and low level criminals, he looks like a lair who stole some stuff
> from Wal Mart and after being catched with pockets full of stolen
> goods, tries to persuade the cops that he done nothing wrong and
> it is a set up, then tries to bribe the cops.
> For me is very clear, he is corrupted crook who will think from the
> first day on the work "damn America, I am here to make money for
> me and my cronies,the time is short, I will steal as much as I can
> from American taxpayers, help my bankers friends so then I will be
> out of job in 4 years, they will at least offer me a warm seat on
> the board of major financial institution.This crash is real, nothing
> can be done to save it and I don't care, only me and only my money,
> good obama is so stupid took me for this job with my reputation of
> thiev, but as obama will be no more than 4 years, we will both steal
> enough as American people are very naive,HAHAHA"

Jan 24 08:33 AM