In JK Galbraith’s magisterial work The Great Crash, 1929 there was (and is: it’s never been out of print) a magnificently sardonic chapter entitled: “In Goldman Sachs We Trust”. I have no doubt that the definitive work on the credit crunch will contain a chapter entitled, equally sardonically: “In Central Banks We Trust’.

I suspect that the understandable interest in the UK in the problems of Northern Rock bank has diverted attention to some extent from the fact that that particular fiasco was symptomatic of a much wider problem: the loss of trust in the banking system - a loss of trust manifested, paradoxically, most vividly in the actions, or inactions, of bankers themselves.

As one senior City — London’s financial district — figure put it to me last week: “It is difficult to be sure whether banks are not lending to one another because they know that while they’re all right the other fellow may not be, or because they suspect everybody else is in as dubious a position as they are.” This lack of trust is blamed for the way individual commercial banks have been reluctant to be seen to borrow emergency funds from their central banks for fear of advertising that they were in trouble. That is why, in a quite sensational coordinated intervention, the leading central banks of the world took a major initiative last week, making emergency funds available to all in what they hope will be a discreet, non-penal and purposeful way.

Trust is an essential, but often underestimated aspect of business and banking. At a personal level, if our regular electrician, plumber or window-cleaner is out of action or unobtainable, most of us would much rather rely on a personal recommendation than risk hiring a cowboy out of the Yellow Pages. Businesses like reliable, regular sources of supply. Banks and building societies like to know with whom they are dealing. I say ‘like’, but of course should say ‘liked’. In the world of securitisation and the ‘parcelling out’ of risk, trust and intimate knowledge of what things were worth and who was holding them became old hat.

In the ultimate irony, while finance ministers and central bankers endlessly repeated the mantra of the wonders of ‘transparency’, banking operations, via such wonderfully opaque financial ‘instruments’ as collateralised debt obligations (CDOs) and structured investment vehicles (SIVs), became increasingly untransparent. I have been in the same room as former Federal Reserve chairman Alan Greenspan when he waxed lyrically, within the hallowed halls of the Bank of England, about the arcane wonders of the spreading and reduction of risk that such financial engineering putatively made possible.

SIVs sound like real vehicles. Unfortunately, they don’t seem to work very well. We all know that it is not much good having a beautifully polished vehicle if there is no oil in the sump. Similarly, it is not much good if bank balance sheets look wonderful but there is insufficient liquidity in the system. What happened after the first signs of trouble appeared in the US sub-prime market and elsewhere in August was that the sump of the banking system ran dry, vast doubts were cast on the value of many of those financial engineering items in balance sheets, and trust collapsed. Things were not helped by what people saw when they were forced to put those ‘off balance sheet’ items back on the balance sheet.

So, a couple of weeks ago, Citigroup, the biggest bank in the world’s biggest economy, had to appeal outside the Western financial system to the Abu Dhabi Investment Authority for funds (at 11 per cent); and last week UBS, after declaring staggering losses in the US sub-prime market, had to shore itself up with funds from the Singapore Investment Corporation and an unnamed source in the Middle East. Nationalisation may be a dirty word in modern market economies, but Western capitalism is happy to bale itself out with help from nationalised concerns further afield.

So what about the impact of all this on the real economy? Nobody really knows. The Organisation for Economic Co-operation and Development puts a brave face on the impact of the credit crunch in its December Economic Outlook. Given the importance of the US economy to the rest of the world, it is interesting that the OECD forecasts a slowdown there but no recession; but it is also interesting that it adds “the trouble is that the probability distribution around this outcome has a fat tail on the downside”.

The US is being cushioned, as our own Professor Wynne Godley, has pointed out, by the impact of the devaluation of the dollar on its exports, which the OECD estimates grew in volume by 10 per cent between the third quarters of 2006 and 2007, against a rise of only 1.5 per cent in imports. Nevertheless, so wide did the gap between exports and imports become during the period of irrational exuberance that the US is still expected by the OECD to run current account deficits of more than $2bn a day for years to come. Wow! — The Guardian