Loss Of Trust Is Hitting Markets

Research shows that the decline of trust in financial leaders and institutions is contributing to the US problems

A Kellogg School Staff Writer

March 2, 2009

As unemployment rates rise, the housing crisis deepens and 401Ks (a retirement savings plan in the US) continue to deplete, it should come as no surprise that the US trust in its financial leaders and institutions has plummeted.

To study the financial implications of eroding trust, Paola Sapienza, associate professor of finance, Kellogg School of Management, Northwestern University, and Luigi Zingales, Robert C. McCormack professor of entrepreneurship and finance, University of Chicago Booth School of Business, have created the Chicago Booth/Kellogg School financial trust index.

The accompanying research shows just how deep this decline in trust runs and how strongly it contributes to the countrys financial problems.

Trust is a powerful motivator of economic behaviour, says Sapienza. Our previous research and anecdotal evidence suggest that lack of trust can have paralysing effects on financing and investments. We developed the financial trust index to measure this often-ignored economic indicator and gain insight into how the governments reaction affects the economy.

The financial trust index will measure public opinion every three months to track changes in attitude over time and will provide a better understanding of public trust, the absence of which, according to Sapienza and Zingales, can bring even the richest, most advanced economies to a grinding halt.

Key findings

Seeking to formalize the relationship between trust and finance, Sapienza and Zingales analysed data from at least 1,000 US households, randomly chosen and surveyed via phone over two weeks in December.

Sapienza and Zingales found that only 22% of those surveyed currently trust the financial system.

Only 12% of the people trust the stock market. This trust is a strong predictor of individuals intentions to increase or decrease their investment in the stock market over the next few months.

Similarly, they found that 11% of the respondents withdrew money from the bank and kept it in cash during the crisis. This behaviour is highly correlated with individuals trust in banks.

They also found that trust in the financial sector has declined sharply over the last few months. When asked how their trust levels had changed over the past three months, respondents indicated a decrease across all categories, with perceptions of the stock market most soured.

One of the goals of this research was to determine to what extent (if any) the perception of current events and government policy affects the trust people have in the financial markets.

Respondents who identify the main cause of the 2008 financial crisis as lax government oversight (16%) or regulation (15%) exhibit the least trust in the market.

Levels of trust were also low among those who blamed companies, citing poor corporate governance (15%) or managerial greed (36%).

While the heavy financial losses suffered can, in part, explain this reduced trust, a crucial factor seems to be the way in which the government has intervened.

While a majority of respondents favour government intervention in financial markets, 80% said the way it intervened has made them less confident in the market.

Even among the respondents who felt that federal intervention in the financial sector should increase, 75% still lost confidence as a result of the recent federal intervention. This percentage rises to 95 among those who did not favour government intervention.

In other words, even among investors who are ideologically favourable to government intervention in financial markets, three out of four have been made less confident by the way the government has intervened.

One of the key factors undermining trust, says Zingales, is the perception that the rules have changed in the middle of the game. The government has done exactly this. What is most shocking is how deeply this has affected the trust of the average American.

Further questions proved that coziness between the government and the financial industry, whether real or perceived, is clearly a problem in the eyes of many Americans. Respondents were asked to choose what motivated former treasury secretary Henry Paulson as he engineered and executed the government response. While 20% of the respondents had no opinion, the remaining 80% were evenly split. Half the group40% of overall respondentsbelieved Paulson acted in the interest of the country.

The other 40%, however, believed that Paulsons plan was meant to benefit Goldman Sachs, the investment bank in which he served as chairman and CEO prior to being appointed treasury secretary.

Send your comments to kelloggscorner @livemint.com

The survey was conducted by Social Science Research Solutions, or SSRS, using International Communications Researchs weekly telephone omnibus service. Exactly 1,034 individuals were surveyed over two weeks, starting 17 December. A fully replicated, stratified, single-stage random-digit-dialing sample of landline telephone households was used to identify survey subjects. Within each sample household, one adult respondent was randomly selected using a computerized procedure based on the most recent birthday method of respondent selection. Once a respondent was contacted, he or she was asked if they were the main or joint financial decision makers in the household. Only individuals replying positively to this question were surveyed.