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Trust and Trustworthiness in Banks: When Does a Trade Become a Trust Violation?

Mon, August 19, 2013 2:50 PM | Robert Hurley (Administrator)

Goldman Sachs and the question of trust was front-page news again in the past few weeks. At the federal courthouse in Lower Manhattan, Fabrice P. Tourre, a former Goldman Sachs trader, was found liable for deliberately misleading investors in the Abacus deal. Tourre worked with one of Goldman’s clients (Paulson) to create an instrument that was designed to fail. Also on Sunday July 21, the New York Times broke the story of Goldman Sachs' exploitation of the regulations for pricing aluminum to bolster profits while driving up the cost of the commodity. At the heart of both cases is the question of whether Goldman used deception to gain an advantage at others’ expense. While the legal system will take months to determine whether Goldman broke any laws, some cogent analysis enables us to decide whether its behavior enhances or erodes its reputation for trustworthiness.

 

Research confirms that trust is a judgment of confident reliance on a person, group or company and in making this trust judgment, we look for: Ability (competent to deliver), Benevolence (fair and concerned about my interests) and Integrity (communicate honestly and honor one's word). Some of these elements of trustworthiness become more difficult when banks act as market makers or begin to trade for their own accounts. For example, if I were one of the presumably sophisticated investors that bought the Abacus instrument and lost a great deal of money, would it reduce my trust of Goldman when I found out that it had worked with another client to pick particularly bad loans to package in the instrument?  Furthermore, would I reduce my trust in the firm when I learned that while it was aggressively selling Abacus to get it off the books, it failed to mention that it was shorting the market and predicting a decline?  What about the Aluminum market? Is it trust-inducing for clever bankers to exploit the arcane formula for how the spot market cost of metal is computed and have consumers pay for it when they buy a can of soda?  Of course learning these facts would demonstrate to me that Goldman was acting competently to serve its own interests and not mine.  My future stance towards Goldman would be to approach the firm with low trust, take care to protect myself and assume that it will look after its own interest – Caveat Emptor (let the buyer beware). Even if none of Goldman’s behavior is illegal, it induces suspicion, not trust. Acting in a trust-inducing manner would have required that Goldman’s competence serve its own interests while respecting and fairly considering others’ interests as well (win/win).

 

If Goldman told me upfront that I was a counterparty and not a client, and should therefore not expect benevolent concern, I would have more trust because it would have respected my interests and have had the integrity to be honest with me. On the other hand, if Goldman led me to think that I was a client, whose interests it would look out for, but then treated me like a counterparty and acted opportunistically to serve its own needs, this is deception and a trust violation.  A trade is a trust violation when there has been a deliberate attempt to deceive in order to gain advantage. Goldman’s first corporate value is that clients come first. This may have been true when the firm was an investment bank in an advisory role, but it is less clear that this is true now that the firm is an underwriter, market maker, and trader. How do you operate when you are a trader? Do you feel you have an obligation to make sure the buyer of your used car is getting a fair deal? Do you offer any negative information about the car if the buyer has not asked about it? Does any of this change if the buyer is someone you expect to have an ongoing relationship with?

 

The high-trust approach would say that you should treat all possible buyers as you would want to be treated. You benevolently share all relevant information with total honesty. The lower-trust approach is to say you have no obligation to protect the interests of the counterparty, and you expect them to do their own due diligence. If you got paid millions of dollars and were under great pressure to make deals, which approach would you take?  The lowest-trust approach is to deliberately deceive the buyer to gain advantage. Like banks, you must be clear about whether you want a reputation for trust and act in a way that demonstrates your trustworthiness. This is the problem of the erosion of trust when bankers become traders and when there are millions of dollars in executive compensation at stake. Community banks tend not to have as many conflicts or huge paydays, and their trust scores have been much higher than the large banks.

 

Senator Elizabeth Warren and the regulators trying to implement Dodd Frank and the Volker rule prohibiting proprietary trading are trying to rein in the scope of the banks. Regulators may not know how to reconstitute the banking system for trust, but it is clear that large banks themselves need to explore their mission and purpose and decide where they want trust relations. Banks must engineer organizational systems that function to consistently send key stakeholders signals of ability, benevolence and integrity. Only then, when they have built authentically trustworthy organizations, will the public’s abysmally low score of trust in larger banks begin to rise. This journey will require a great deal of self-examination and change, but the banks that lead the way will end up with a real competitive advantage. After all, the word credit comes from the word credo – to believe, to trust.

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