THE TRUST ISSUE GOES DEEPER THAN THAT THOUGH:

Financial recovery hinges on trust (Mark Zandi, 4/25/10, Philadelphia Inquirer)

Odd as it may sound, the U.S. financial system is also one of our biggest global advantages. The Italians make great sunglasses, the Russians make excellent vodka, but Americans make the best financial products. Not always, as the financial meltdown has made clear, but in most times our financial system has done an admirable job of taking what little saving we do and using it to finance the investment needed to power the most productive economy on the planet.

To revive our financial system, however, trust needs to be restored. Unless those who lend money as well as those who borrow it believe they are getting a fair shake, credit won't flow, at least not at reasonable cost. Trust is particularly important to attract global investors to buy U.S. bonds, stocks, and other financial products. With so many Treasury bonds to sell to fill our gaping budget deficit, we need global investors to have full faith in our system.

Financial reform can start to accomplish this, for example, by taming the wild and woolly derivatives market, putting trading on exchanges where transactions can be monitored and regulated. Private or over-the-counter derivatives trading is where much of the current smoke is coming from, including the Goldman Sachs suit. Regulation is also necessary to ensure that investors have the financial wherewithal to meet the obligations they make in these deals.

Perhaps the most interesting moment of the credit crisis came when the Administration followed rational free market theory and allowed Lehman Brothers to fail, not appreciating that it would undermine faith in the financial system itself.

Posted by Orrin Judd at April 25, 2010 6:50 AM