Wary investors could learn a lot from my nephew
Both need incentives to rebuild their shaken trust.
What lies at the heart of the current financial crisis? An important clue: It's similar to a problem I faced this summer with my 6-year-old nephew.
Playing around at the beach one day, I said to him, "Here, let me flip you into the water." "NO!" he said with panic, and from then on, I couldn't get him to play. "I promise not to flip you," I told him. But though we love each other, he would not believe me. What to do? I was face-to-face with the "promise problem."
The promise problem goes like this: "How do I know you will keep your word? How do I know you'll do what you say?" And that, in a nutshell, is what is shaping our economic lives – more than economics or mob psychology.
Like my nephew, investors now look at borrowers' promises and shout, "NO!" For good reason, each seems to wonder, "How do I know borrowers will pay what they promise?"
One basic solution is to use something called a trust support – any mechanism or arrangement that can help boost trust when a mere promise won't cut it. The right trust supports can make a big difference.
To the point: "I promise not to flip you," I told my nephew, "and if I do, I'll give you $10." This instantly changed everything and for the rest of the afternoon we played happily together.
What changed? I gave him a trust support. There were many I might have tried. I might have asked his mother to vouch for me, or let the lifeguard watch me carefully. Here, I offered to penalize myself and compensate him if I broke my word. It worked. I'd made my commitment reliable enough for him to accept it. And then I followed through.