Comment on 'Trust Crisis' identified by the Financial Trust Index

by Prof. Didier Sornette (13 Feb 09)

We fully agree with the key point that the "asset'' that has been lost is "trust'' (see essay Trust! Why It Has Been Lost And How To Regain It, 22 October 2008 at http://www.er.ethz.ch/essays/regain_trust), which has amplified and is still amplifying the waves of financial losses and economic recessions. However, one should not mix up consequences and causes. Yes, the economic hardships are amplified by the loss of trust. But this is very far from explaining the fundamental cause of our problems. 

The fundamental cause is the succession of bubbles (see http://www.er.ethz.ch/essays/regain_trust and http://www.er.ethz.ch/essays/financial_crisis_solutions) that led to an ILLUSION OF WEALTH. The expansion of the real-estate and financial spheres had reached levels decoupled to anything real, and people had been extracting huge amount of capital from this illusory "permanent money machine''. The present contraction is just the return to a pre-bubble regime.

Having said that, the loss of trust and the ambient pessimism are leading to what we call "negative bubbles'', i.e., procyclical overshooting of the deflation of the financial and economic sphere (more soon with quantitative analyses on the FCO site http://www.er.ethz.ch/fco/index). 

This has important consequences on how to help economies to recover: not by spending stimulii since over-spending was the problem before, but by investing in long-term human capital and productive infrastructures.