The Persistent Trust Deficit

The following is an excellent excerpt from the book “THE ONLY GAME IN TOWN: Central Banks, Instability, and Avoiding the Next Collapse” by Mohamed A. El-Erian from Part III: “From the What to the So What” from Chapter 12: “The Persistent Trust Deficit” on page 91 and I quote:

“Trust, like the soul never returns once it goes.”         –PUBLILIUS SYRUS

“Issue 4: The loss of institutional credibility is part of a more generalized erosion of trust in politicians and the “system” as a whole.

Institutional credibility is crucial to generating and maintaining economic prosperity.  Indeed, it is often the most important factor that differentiates stable mature economies from volatile and unpredictable ones.  And the credibility of many institutions has come under significant attack in recent years.

It is difficult to explain to the general public how governments and central banks stood by and allowed irresponsible financial risk taking to tip into a crisis and subsequent prolonged mediocrity.  It is even harder to explain why they then bailed out banks with trillions of dollars; these were the very entities that many regard as the perpetrators of the crisis.  And it is virtually impossible to defend the fact that so few bankers have been punished for their irresponsible behaviors.

Accentuating all this are stories still coming out about bank malfeasance.  Almost a decade after the onset of the global financial crisis, legal fines are still being imposed, including for manipulating foreign exchange markets and LIBOR, a key commercial interest rate set by banks.  Meanwhile, new research in shedding light on the extent to which some banks went around the rules while others disregarded even the most basic elements of client service and risk management.

Former chairman Bernanke was among those commenting on this phenomenon.  Shortly after leaving the Fed at the beginning of 2014 he observed that “the natural reaction from the guy on Main Street is ‘how come you’re bailing them out and not bailing me out?’  By preventing the system from collapsing we’re protecting the economy, we’re protecting you.  But it’s a complicated argument to make and I don’t think we always made it as well as we could have.”

Former secretary Geithner went further.  Recognizing the difficulty of selling to the public the case for bailouts, he reacted quite sharply to those who suggested that such assistance to banks would encourage renewed irresponsible behavior down the road.  He saw little merit for the claims of those he labeled in his book “moral hazard fundamentalists.”

Recognizing the continued anger in the country, an active group of politicians is interested not only in de-risking the banks further but also in gaining greater insights into how their de facto main supervisor, the Federal Reserve, operates–so much so as to push an inherently nonconfrontational Chair Yellen to warn in July 2014 congressional testimony that greater Fed oversight could be a “grave mistake.”

Yet this phenomenon will not dissipate anytime soon, especially as it united lawmakers on both sides of the political aisle, albeit for different reasons.

Republicans tend to be concerned about the Fed’s involvement in markets, including a balance sheet that had grown to $4 trillion by the beginning of 2015.  Moreover, as the former Fed vice chairman Donald Kohn stated in December 2013 when commenting on the portfolio [that] could grow almost without limit,” “there’s some legitimacy in these discomforts [regarding] the potential financial stability effects”–a concern echoed by Jeremy Stein when he served as a member of the Fed’s Board of Governors.  It is these sorts of issues that lead lawmakers, such as Texan Republican Jeb Hensarling, who chaired the House Financial Services Committee, to threaten “the most rigorous examination and oversight of the Federal Reserve in its history.”

On the other side of the aisle, Democrats remain worried about the Fed being too close to financial markets and especially way too friendly with banks.  In a November 2014 hearing of the Senate Banking Committee, Senator Elizabeth Warren of Massachusetts told Bill Dudley, the president of the New York Fed, “you need to fix it, Mr. Dudley, or we need to get someone who will.”  The comment was particularly notable since Congress has no say over appointments at the New York Fed.

Other countries have looked for additional ways to rein in irresponsible risk taking by banks.  In December 2014, the Netherlands opted for making bankers take an oath that “they will endeavor to maintain and promote confidence in the financial sector, so help me God.”  As Liz Alderman, the New York Time‘s chief European business correspondent, wrote, “the sinners of the banking system seem so uncowed by regulators and prosecutors that one country is trying a higher deterrent: the fear of God.”

All this constitutes a threat to the “branding” of modern central banking that started to take hold in the United States in the 1980s under then-Fed chairman Paul Volcker.  Publicly declaring a war against high and debilitating inflation, he delivered a secular victory over price instability, restored the standing of the Fed, and gave its brand quite a mystique.  The mystique was augmented under the long tenure of Chairman Greenspan, when, as noted earlier in the book, the Fed and its “maestro” were celebrated for having brought about a seemingly permanent period of economic prosperity, low inflation, and financial stability.

Just like in business, central banks’ strong brand standing is intricately interlinked to their operational effectiveness.

Strong brands are known around the world for reliability in delivering on quality and on their praise of good outcomes.  The stronger the brand, the more likely that consumers may even act just on announcements alone–say, thousands of people willing to stand in line to purchase a newly released product despite having relatively limited information about it.  Moreover, in some very limited cases, a brand (like Apple) can also create consumer “enchantment,” which makes the company even more effective in selling innovations and fending off competitors.

Central banks have essentially put their hard-earned brand in play: first by failing to convince the public at large of the reasons for bailing out irresponsible banks; and then by taking on massive policy responsibilities and struggling to deliver fully, given limited tools and the lack of support from other government agencies.  They have done this not by choice but rather by necessity because of other policy-making entities failing to step up to their responsibilities.

In the case of the ECB, the situation has been complicated by a few other factors.  One is the difficulty of maintaining unanimity on a governing council representing many countries (with different interpretations of the past, present, and future); another is recurrent questions about the legality of certain measures.  It also has not helped that, like other members of this specially formed crisis management grouping for the Eurozone, the central bank has had to operate under a rather clumsy, complex, and at times troubled “troika” arrangement–one that brings together three institutions (the ECB, the European commission, and the IMF) that are subject to varying degrees of economic influence, have different mandates, and tend to differ in their operational modalities and even their mindsets.

The list of institutional worries does not stop here.  Having been subjected to a prolonged period of financial repression, savers have started to realize that, due to partial policy responses on both sides of the Atlantic, they are being sacrificed in attempts to rehabilitate banks and the economy.  It is not just about nonexistent and in some cases negative interest rates on the main low-risk saving instruments, be they government bonds, savings accounts, or certificates of deposit.  It is also about how the growing number of institutions that provide long-term protection, such as life insurers, are having to reduce their offerings as they are gradually pushed toward losses by the ultra-low-yield environment.

All this comes together to a boil because of the visible inability of political systems to respond.  As noted earlier, try explaining how for five straight years up to now, the U.S. Congress was unable to deliver a new budget.  How silly political bickering shut the government down for almost three weeks and, on different occasions, brought the supplier of global public goods to the verge of a technical default.  Meanwhile, at a time of policy needs, measures of congressional productivity, including bills passes, have reached record lows.

It should therefore come as no surprise that in the General Social Survey for 2014, conducted by NORC, the independent research organization at the University of Chicago, the number of surveyed Americans having “a great deal of confidence” in Congress was only 5 percent; it stood at 11 percent for the executive branch.

This all underscores a broader phenomenon, one that has gotten a lot worse in recent years and radically inhibits proper economic and financial management–an erosion in the credibility of economic institutions and the politicians that oversee them.

This was not just a domestic issue for the United States.  Travel outside the country and try responding to criticisms of how Congress has blocked reforms to the IMF that virtually every other country in the world has approved–and lawmakers have done so even though these reforms do not erode the voting power of America, involve no incremental financial appropriation, and in fact were initially spearheaded by the United States itself.  Indeed, these reforms serve the U.S. national interest.  Yet rather than being judged on merit, they have been derailed by petty political bickering, paralyzing polarization, and undue stubbornness.

Other countries have had their share of trust issues and near misses.  Witness how in 2014 London almost bungled a referendum that came close to seeing Scotland exit the United Kingdom, a development that would have entailed considerable uncertainty for both nations, as well as the European Union.  Meanwhile, throughout Europe there has been a surge in support for nontraditional and anti-establishment parties, an issue we address in the next chapter.”


“In his next book, The Only Game in Town, Mohamed El-Erian has done several important things superbly.  First, he has presented the first really comprehensive assessment of the multiple challenges to sustainable and inclusive growth facing a wide range of countries and the global economy.  Second, he does it through the illuminating lens of central banks and monetary policy–with few exceptions, the only game in town.  Third, he then deftly and insightfully dissects the limits and risks of this almost ubiquitous one-handed policy response.  And fourth, he argues persuasively that this is a journey we cannot continue; that we will break either right to a much superior level and quality of growth, or left to declining performance and rising instability.  He then suggests mind-sets that will help everyone–policymakers, and the rest of us–navigate this complex and uncharted territory.  It is a tour de force.”  –Michael Spence, Nobel Laureate and professor of economics, Stern School of Business, NYU

LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member and USAF Veteran


About tim074

I'm a retired dairy farmer that was a member of the National Farmer's Organization (NFO). Before going farming, I spent 4 years in the United States Air Force where I saved up enough money to get my down payment to go farming. I also enjoy writing and reading biographies and I write about myself as well as articles and excerpts I find interesting. I'm specifically interested in finances, particularly in the banking industry because if it wasn't for help from my local Community Bank, I never could have started farming which I was successful at. So, I'm real interested in the Small Business Administration and I know they are the ones creating jobs. I have been a member of Common Cause and am now a member of Public Citizen as well as AARP. I have, in the past, written over 150 articles on the Obama Blog ( and I'd like to tie these two sites together. I'm also on Twitter, MySpace and Facebook and find these outlets terrifically interesting particularly what many of these people did concerning the uprising in the Arab world. I believe this is a smaller world than we think it is and my goal is to try to bring people together to live in peace because management needs labor like labor needs management. Up to now, that hasn't been so easy to find.
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