Broken Trust with the Financial System

October 19th, 2010

Since we first reported on the potential of a $144 billion payout of compensation to the key players on Wall Street, I have found myself disturbed. At first I thought it was the injustice of it all. To some extent it is. Yet it felt as if I was overlooking something even more troubling.

Today’s comments from our regular contributor, Michael Mandel, brought into focus the root of my discomfort. It appears that we have transcended the need for trust at the very root of our financial and governmental systems.

Here’s what I mean:

The key participants are acting with seeming impunity. Sure we jail and vilify the occasional “big crooks” like Bernie Madoff, but even in that case, there seems to a two tiered system of trust at work. It appears to be okay to continuously strip away the wealth (and peace of mind) of the working class, but please oh please, don’t do this to those folks like us who have wealth. We expect to be treated differently.

Michael made the point that there may be a backlash by some of the wealthy who were left holding the bag when the bottom fell out on the value of the collateralized debts. They bought these debts on the promise that they were as good as gold. My sense is Michael’s wrong and the system is finding a way to take care of these bruised egos so trust will be restored within this group.

That leaves the rest of us. We are asked to trust the system once again. For without our trust it will again fail.

I feel a bit like Charlie Brown. I am being asked by Lucy, who has again teed up the football, to trust once more that she won’t move it when I am ready to kick.

In looking into the basis of the large Wall Street payouts I again see trust as an important issue, at least for me. You see the larger profits of financial institutions are based upon their reporting lower credit risks. Yet if you look around at our neighborhoods, the unemployment offices and soup kitchens the picture is much different.

What you may not be aware of is that the rules for accounting for risk by our largest banks have been radically altered. During the depths of the financial crisis, the federal government under the direction of Henry Paulson, then Secretary of Treasury (and you may recall a former CEO of Goldman Sachs) forced the Fair Accounting Standards Board (FASB) to rewrite the rules of how banks accounted for potential bad debts. In the past the rule was that you would value your assets at what was called fair market value (or the price you could sell it for today if you needed to). You may have heard this called Market to Market. Seems reasonable, but if the banks had to continue to follow these rules then they would be insolvent. Since we couldn’t have that, we forced FASB to allow banks to set the value for their assets. Kind of like letting you say how much your house is worth when you apply for a loan. We know how well that would go over, in fact, you could be prosecuted. With this new rule in place, banks have been slowly reducing the amount they set aside for bad debts. This allows their profits to rise. So much so that Citibank, which was almost out for the count, reported over $2B in profits for the quarter ending in September.

Why does this matter? Well, it’s the profits of the banks that set up the basis for bonuses. Starting to see the problem? I set the rules that allow me to make more money and get big money to take home for myself. This is the same set of incentive structures that led to the financial meltdown.

Now back to trust… If the system is based upon a false set of understandings, how long can it last? Not too long without some other support from you and I. So I have lost trust in the whole system – banks, regulators and legislators. This broken trust can only be repaired through authentic dialog that doesn’t exist.

So what am I doing? I am continuing to support my local community bank. I am doing all I can to buy whatever possible from local providers of goods and services. I am not pretending that something challenging isn’t going to happen. I am shedding all debt and reducing our family spending. If there is a backlash to the breakdown in trust I am prepared. If I am wrong and things go on just as they have, well then I am still better off. Think about it… You do make the difference.

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