Four years ago, there were fears of a financial meltdown — a term borrowed from the nuclear power industry. Now there are fears of a real meltdown.
Checking evacuees from the area around the damaged Japanese power plants for radiation. Utility executives, like financial ones, may have let overconfidence overwhelm their sense of risks.
Employees leaving Lehman Brothers' offices after its 2008 bankruptcy filing.
Comparing the two events may risk seeming insensitive to the rising human toll in northern Japan, but there are similarities in causation. In each case, overconfidence born of experience led to increased risks once a disaster unfolded.
Fortunately, there is reason to hope that the worst fears will not be realized. When — let us hope it is not “if” — the radiation releases are controlled, Japan can begin to rebuild and the worst economic fears could prove to be as exaggerated as the depression fears that paralyzed financial markets two years ago.
In the years preceding each meltdown, the very act of reducing apparent risks may have increased actual risks. In the world of finance, there was a general acceptance of the idea that banks and their regulators had developed sophisticated risk models to prevent a disaster. As lending grew more reckless, there was confidence that no real risks were being taken.
In Japan, the risks of earthquake and tsunami were well known, and believed to have been dealt with. An earthquake could damage a nuclear plant and its vital cooling process if power to the reactor were cut off. So backup generators were built and batteries installed to provide power even if the generator did not immediately kick in. A tsunami could cause flooding. So huge sea walls were built to prevent floods.
All the precautions had worked in previous earthquakes, and that history was reassuring.
Unfortunately, it appears that those building the nuclear plants assumed that the risk from tsunamis had been eliminated by the precautions that others took. The backup generators were behind the flood walls, but they were not on high ground, as would have seemed necessary without faith in the walls. So the generators flooded and the cooling systems broke down. That led to radiation releases. Whether it will lead to something much worse is still unknown.
In the world of finance, the assumption that safeguards would prevent disaster led people to believe it was safe to borrow heavily. There had, after all, been a prolonged period in which markets were not turbulent and there were only profits, not losses, to be realized from taking on the additional risk of leverage. As the economist Hyman Minsky wrote years earlier, “stability is destabilizing” because it encourages confidence that benign circumstances will endure.
We learned from the financial crisis that the comfortable assurances that authorities knew what to do were misplaced. Central bankers had insisted that it was futile and unnecessary for them to look out for bubbles, since they knew how to deal with the results if one did burst. The 2001 recession after the collapse of the technology stock bubble was both short and mild. The Federal Reserve emerged triumphant, its wisdom and capabilities widely admired.
But this time it turned out that easing monetary policy was not nearly enough, and the United States will be dealing for years with problems caused by homeowners who are — to use another term that seems newly inappropriate — underwater. Many, but not all, of those once-confident central bankers now say they were wrong.
It has become clear that the Japanese nuclear industry was ill equipped to deal with the current disaster. Otherwise the cooling systems would have continued functioning even if the earthquake had disabled plants. The cost — in lives and yen — is as yet unknown.
Each case — a collapse of house prices and a cascade of problems threatening a large release of radiation — was viewed as so improbable that it could be virtually ignored in considering risks. Those who counseled otherwise were viewed as alarmists.
What was not considered sufficiently, perhaps, is just how serious an unlikely risk may be. If it is bad enough, the risk may not be worth taking, no matter how good the odds. There is a reason people do not play Russian roulette, even if the odds are highly favorable. It is a game you lose only once.
At a time when brave workers are risking death from radiation, when whole communities have been destroyed by the tsunami and survivors are suffering in makeshift shelters, it seems inhuman to even suggest that of the two meltdowns, the financial one was worse. Bank failures do not kill people.
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