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Measuring trust

Associate Professor Paola Sapienza's Financial Trust Index adds a grim new measure of the nation's financial decline

By Brad Wible

  Paola Sapienza
  Professor Paola Sapienza
Photo © Evanston Photographic Studios
Adapted from KELLOGG INSIGHT articles based on the research of Kellogg professors. For the full text of these and other INSIGHT articles, please visit the KELLOGG INSIGHT Web site.

Consumer spending, home prices, 401(k) values and employment levels are but a few of the economic vital signs that have plummeted during the past months.

New research by Paola Sapienza, Kellogg associate professor of finance, and Luigi Zingales, a University of Chicago professor, adds a grim, new measure of our national financial decline, one that may underlie and influence many others.

The researchers' Financial Trust Index is based on survey results and indicates how trust in U.S. financial institutions and government leadership has eroded. It also suggests possible causes and effects that must be confronted in order to rebuild the economy. The survey was administered to more than 1,000 adults in December 2008 and will be repeated every three months.

The survey indicated that banks were the most trusted institution, although respondents teetered on the brink between trust and mistrust. Government, large corporations and the stock market plumbed to even greater depths of mistrust. These institutions were all considered less trustworthy than "other people in general," the only category to earn a more-trusted-than-not-trusted rating. In spite of all that has happened, average Americans appear to still have a modest level of faith in their neighbors.

Trust is a critical element of a broader phenomenon: social capital. Defined as the shared habits, values and trusting relationships that span and unite a society, social capital influences the welfare and development of an economy.

Trust is also a powerful motivator of economic behavior. The survey revealed that trust in brokers and the market influenced plans to increase or decrease investment. Trust in bankers and banks influenced plans to withdraw deposits. Trust in markets plummeted the most among those whose personal wealth eroded the most over the past year. People with the least trust in the market also blamed the government, citing lax oversight or regulation. Trust was similarly low among those who blamed companies, citing poor corporate governance or managerial greed. Trust in the market was highest among people who blamed excessive government intervention or global imbalances.

"It's a leap of faith to give money to a broker to invest in the market," Sapienza says. "You have to trust that the broker won't run away with the money, that a manager will run a company in the best interests of the shareholders – not for personal gain."

Even though 32 percent of respondents blamed the government for not providing enough regulation or oversight to avert the current crisis, 80 percent lost confidence once the government took action. Forty percent of people even believed that the bailout was meant to benefit Goldman Sachs, the investment bank where former Treasury Secretary Henry Paulson once served as chairman and CEO.

This presents an enormous problem, suggests Sapienza. "When people started walking away from the market, the government's reaction wasn't to intervene to increase transparency. They just pumped money," she says. "But people now are saying, 'We think government should intervene, but they shouldn't just give money to Citibank.'"

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