Meltdown: not just a metaphor ... by gimleteye

Since we are on the topic of meltdowns, Nobel laureate Joseph Stiglitz draws a parallel between the financial meltdown and the nuclear disaster unfolding in Japan. The FPL lobbyists and executives who read our blog may believe it from Stiglitz if not from me: "Meltdown: not just a metaphor: Vested interests cause both our financial system and the nuclear industry to compulsively underestimate risk. This is an excellent OPED, I urge you to read it. (Click, read more)
Wednesday 6
April 2011

The consequences of the Japanese earthquake – especially the ongoing crisis
at the Fukushima nuclear power plant – resonate grimly for observers of the
American financial crash that precipitated the Great Recession. Both events
provide stark lessons about risks, and about how badly markets and societies
can manage them.

Of course, in one sense, there is no comparison between the tragedy of the
earthquake – which has left more than 25,000 people dead or missing – and
the financial crisis, to which no such acute physical suffering can be
attributed. But when it comes to the nuclear meltdown at Fukushima, there is
a common theme in the two events.

Experts in both the nuclear and finance industries assured us that new
technology had all but eliminated the risk of catastrophe. Events proved
them wrong: not only did the risks exist, but their consequences were so
enormous that they easily erased all the supposed benefits of the systems
that industry leaders promoted.

Before the Great Recession, America's economic gurus – from the head of the
Federal Reserve to the titans of finance – boasted that we had learned to
master risk. "Innovative" financial instruments such as derivatives and
credit default swaps enabled the distribution of risk throughout the
economy. We now know that they deluded not only the rest of society, but
even themselves.

These wizards of finance, it turned out, didn't understand the intricacies
of risk, let alone the dangers posed by "fat-tail distributions" – a
statistical term for rare events with huge consequences, sometimes called
"black swans". Events that were supposed to happen once in a century – or
even once in the lifetime of the universe – seemed to happen every 10 years.
Worse, not only was the frequency of these events vastly underestimated; so
was the astronomical damage they would cause – something like the meltdowns
that keep dogging the nuclear industry.

Research in economics and psychology helps us understand why we do such a
bad job in managing these risks. We have little empirical basis for judging
rare events, so it is difficult to arrive at good estimates. In such
circumstances, more than wishful thinking can come into play: we might have
few incentives to think hard at all. On the contrary, when others bear the
costs of mistakes, the incentives favour self-delusion. A system that
socialises losses and privatises gains is doomed to mismanage risk.

Indeed, the entire financial sector was rife with agency problems and
externalities. Ratings agencies had incentives to give good ratings to the
high-risk securities produced by the investment banks that were paying them.
Mortgage originators bore no consequences for their irresponsibility, and
even those who engaged in predatory lending or created and marketed
securities that were designed to lose did so in ways that insulated them
from civil and criminal prosecution.

This brings us to the next question: are there other "black swan" events
waiting to happen? Unfortunately, some of the really big risks that we face
today are most likely not even rare events. The good news is that such risks
can be controlled at little or no cost. The bad news is that doing so faces
strong political opposition – for there are people who profit from the
status quo.

We have seen two of the big risks in recent years, but have done little to
bring them under control. By some accounts, how the last crisis was managed
may have increased the risk of a future financial meltdown.

Too-big-to-fail banks, and the markets in which they participate, now know
that they can expect to be bailed out if they get into trouble. As a result
of this moral hazard, these banks can borrow on favourable terms, giving
them a competitive advantage based not on superior performance, but on
political strength. While some of the excesses in risk-taking have been
curbed, predatory lending and unregulated trading in obscure,
over-the-counter derivatives continue. Incentive structures that encourage
excess risk-taking remain virtually unchanged.

So, too, while Germany has shut down its older nuclear reactors, in the US
and elsewhere, even plants that have the same flawed design as Fukushima
continue to operate. The nuclear industry's very existence is dependent on
hidden public subsidies – costs borne by society in the event of nuclear
disaster, as well as the costs of the still-unmanaged disposal of nuclear
waste. So much for unfettered capitalism!

For the planet, there is one more risk, which, like the other two, is almost
a certainty: global warming and climate change. If there were other planets
to which we could move at low cost in the event of the almost certain
outcome predicted by scientists, one could argue that this is a risk worth
taking. But there aren't, so it isn't.

The costs of reducing emissions pale in comparison to the possible risks the
world faces. And that is true even if we rule out the nuclear option (the
costs of which were always underestimated). To be sure, coal and oil
companies would suffer, and big polluting countries – like the US – would
obviously pay a higher price than those with a less profligate lifestyle.

In the end, those gambling in Las Vegas lose more than they gain. As a
society, we are gambling – with our big banks, with our nuclear power
facilities, with our planet. As in Las Vegas, the lucky few – the bankers
that put our economy at risk and the owners of energy companies that put our
planet at risk – may walk off with a mint. But on average and almost
certainly, we as a society, like all gamblers, will lose.
That, unfortunately, is a lesson of Japan's disaster that we continue to
ignore at our peril.
http://www.guardian.co.uk/commentisfree/cifamerica/2011/apr/06/japan-nuclear
power