The Madoff affair--in which prestigious Jewish financier Bernard Madoff bilked investors, many of them observant fellow Jews and Jewish foundations, out of billions of dollars via an elaborate, long-lived Ponzi scheme--is a fascinating lesson in the nature and evolution of social trust. Even before Edward Banfield made it a topic of social scientific research, the idea that the degree to which a society's members can trust each other affects their economic, social and political well-being was a matter of common sense. Recent popularizers such as Francis Fukuyama and John Kay have focused on the role of culturally nurtured social trust in economic prosperity, with Amy Chua (about whom I've written previously) concentrating on the economic success of certain minority populations.
One such population, of course, is the Jewish people, and the Madoff scandal illustrates the extent to which Jewish success is a result of what Fukuyama would call a "high-trust" culture, where norms and traditions cause members to expect and rely on high standards of behavior from each other. There is a downside to these expectations, though: Madoff was able to bilk so many people out of so much money precisely because they considered it implausible that someone so deeply embedded in, and respected by, the Jewish community could be such a crook.
This sort of "affinity fraud" is a familiar weakness of trust based on cultural norms. Trust is inherently brittle: the more weight it carries--that is, the greater the reliance that is placed in it--the greater the temptation for a Madoff type to come along and betray it for his own gain. Back in the days of family-owned banks and letters of introduction, for example, Madoff might have been able to wipe out the life savings of a few relatives and gullible acquaintances. But in an age of highly portable capital and global commerce, inhabited by much larger, richer networks of trust, Madoff was able to tap into, and ultimately destroy, an amount of wealth equivalent to the annual GDP of a small country.
And here's where Madoff's other cultural affiliation comes into play. America is exceptional in many ways, but one of them is that among high-trust cultures, it's the least rooted in cultural norms, traditions and expectations. As the world's most culturally diverse, individualistic and libertarian nation, it simply cannot, and collectively has no desire to, cultivate in its inhabitants the kind of rigid adherence to reliable behavioral norms that's inculcated in, say, every Japanese. Instead, America has built a remarkable infrastructure of trust out of a combination of private institutions and governmental regulations that effectively substitute for cultural norms as a way of mediating trust between parties that wouldn't otherwise trust each other.
Consider, for example, that quintessential American institution, the credit card. With it, an American can walk into an office thousands of miles from home and buy or rent very valuable goods--a luxury car, for instance--from a total stranger, without so much as a downpayment. Yet the card represents no personal acquaintance to speak of, either between the cardholder and the issuer, the issuer and the merchant's acquirer, or the merchant's acquirer and the merchant. The bonds that restrain their behavior are rather a combination of laws, commercial practices and incentives that successfully convince the participants--most of the time--that obeying the rules of the credit card game is in their interest.
Obviously, this type of behavioral restraint is less effective than the social norms of other high-trust societies, as America's stratospheric rates of crime, bankruptcy, lawsuits and other forms of conflict demonstrate. But its flexibility and libertarian commercialism seem to make it more efficient--in the dynamic modern world, at least--than trust based on tradition and social norms. In much of the world, in fact, financial structures have gradually been pulled towards American styles of operation, rather than vice versa.
On the other hand, the brittleness of trust doesn't go away just because it's mediated by commercial institutions rather than social norms. What affinity fraud has been to high-trust societies, financial bubbles have been to American-style economic trust systems. And the longer and more large-scale the mutual trust gets, the more catastrophic the shattering.
The recent (and ongoing) financial crisis , for example, apparently culminated in a massive run on money market funds. Money market funds are, of course, largely unregulated, uninsured funds that store trillions in ordinary depositors' money--money that could instead have been stored in government-guaranteed deposit accounts at banks. (Those government guarantees, let us remember, were put into place after similar runs on banks during the early 1930s.) Apparently, millions of depositors trusted the funds enough to prefer their higher returns to the comfortable security of government-guaranteed bank deposits--and would have collectively lost trillions of dollars as a result, had the government not intervened to protect them. Lulled into a collective overextension of trust, these investors came close to having their trust instantaneously and utterly destroyed--with all the inevitable economic consequences such a drastic drop in social trust can be expected to bring.
I've explained previously how expectations of continued economic prosperity can undermine that same prosperity. The effect of trust is similar: a continued boom inflates social trust, increasing the opportunities for exploiting it, until it suddenly shatters, leaving society much the worse off economically. As we observe the twin wrecks of a housing system built on trust in homebuyers' reliability, and a retirement savings system built on trust in the stock market's reliability, we would do well to remember that trust is as subject to bubble dynamics as any other valuable commodity.