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Catastrophe thinking

While I'm on the topic of Michael Lewis's "The Big Short," one of the interesting threads running through the book is Lewis's fascination with the mental habits of the hardy few who recognized that all of Wall Street was nuts and the financial system was going to crack in half.

One of the traits was a comfort with the lurking potential of catastrophe. Take Lewis's description of Ben Hockett, one of the investors who bet hard against the subprime market. "Ben shared Charlie and Jamie's view that people, and markets, tended to underestimate the probability of extreme change, but he took his thinking a step farther. Charlie and Jamie were interested chiefly in the probabilities of disasters in financial markets. Ben walked around with some very tiny fraction of his mind alert to the probabilities of disasters in real life. People underestimated these, too, he believed because they didn't want to think about them."

This willingness to believe in catastrophe was necessary because believing the subprime market was a fraud meant believing that we were hurtling toward a global financial crisis. That's hard to wrap your mind around, and most people shy away from such conclusions. But the pessimists were right. So there's something to this mode of analysis.

The obvious question worth asking is what else this mode of analysis can tell you. Where do the numbers and the historical evidence point one way, but the system seems oddly complacent?

The obvious place is the federal debt. It's trite to say the trend is unsustainable. And it's hard to look at recent political history and say we're capable of making a radical adjustment. But that's definitely what the numbers suggest. This is something that a lot of people in Washington (and in the country more broadly) recognize in theory, but that theoretical understanding hasn't translated into the sort of practical urgency you'd expect. The Conrad/Gregg debt commission, for instance, got filibustered to death in the Senate. The fact that people can imagine catastrophe doesn't mean they want to think about it, or do what's necessary to address it when that requires importing a dose of the pain into the present.

Other contenders? Global warming is one. A lot of people would name peak oil as another. I'm sure there are a bunch more I'm forgetting. But that's what the comment section is for, right?

By Ezra Klein  |  April 7, 2010; 11:05 AM ET
Categories:  Books  
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Robert Pindyck, "The Economic and Policy Consequences of Catastrophes"

Posted by: bdballard | April 7, 2010 11:17 AM | Report abuse

I would throw the series finale of LOST into this.

Posted by: patrickbyers | April 7, 2010 11:37 AM | Report abuse

IMHO the willingness to believe in the possibility of disasters like this is a subset of a larger philosophy that I have tried to live by for the last decade or more: always question your assumptions. As a former conservative who grew up in a Republican household spouting things like "liberals don't want to kill criminals but they're fine with killing babies", it was the slowly-developing recognition of the flaws in my thought processes that led me towards the center and ultimately to the left. For many in the financial world, they assumed the economy couldn't crash as hard as it did. With that underlying assumption made, they were completely blind to the evidence before them.

Question as many of your beliefs as often as you can; try to identify the assumptions you originally made in developing those beliefs and then try to find out whether those assumptions were correct. It can be an enlightening and sometimes surprising exercise, but you're guaranteed to be better off for your efforts.

Posted by: BigTunaTim | April 7, 2010 11:40 AM | Report abuse

I'll offer a counterexample. For 100 years, the looming catastrophe was negative eugenics: scientists around the world concluded that allowing two "races" to mingle and reproduce would cause the end of civilization. The Dean of St. Paul's concludes his volume of __Outspoken Essays__ (1922) by writing in an 20k word essay that "Galton tried to enlist the interest of the public in this work, but the response was not very encouraging. [...] A nation which takes for prophets irrationalists like Mr. Kidd and Mr. Chesterton has no right to complain of emotional politicians, who despise accurate knowledge. It has deserved them. The anti-scientific temper is our enemy today -- a worse enemy than the Germans. It has become shameless and aggressive, taking advantage of certain anti-intellectualist tendencies in modern philosophy, and of dissentions in the scientific camp."

Of course, Mr. Kidd and Mr. Chesterton, who warned of the catastrophe of the bandwagon effect, have been proved correct and those who warned of the catastrophe of race-mixing have been proved incorrect. Both predicted catastrophes deserved attention... and the seemingly innocuous catastrophe deserved more attention than it received. What if the voices of opposition had never been heard?

Posted by: rmgregory | April 7, 2010 11:42 AM | Report abuse

Global warming is an interesting issue through Michael Lewis' lens because you have first the general (not well-informed) consensus that things can't be that bad. This is most of the public andf some gov't people, especially in the last Admin. Then there is the scientific consensus that indeed they are bad, that no one is seeing what is obvious to the really informed. They are the alarmists (in a non-pejorative sense. Within the scientific community they are the consensus, unlike those questioning the financial system.

And then there are the deniers. Some of these are just doing what appears to be in their short-term economic interest (oil, coal). Some are ideological contrarians, who like (or have) to be against whatever the Progressives seem to be for. Some just like to be contrarian. Most of the contrarians don't really understand the science behind global climate change, at least not like the people out there measuring ice cores and ocean temperatures and historical atmpospheric composition.

Who are the equivalent of Lewis' short sellers? I don't think it is the contrarians, certainly not those for whom denial is in their economic interest. They are like Goldman Sachs and JPMorgan Chase. They really don't care what happens to us chumps.

Posted by: Mimikatz | April 7, 2010 11:48 AM | Report abuse

I'd say what they all have in common is Aspergers or Asperger-like social dysfunction. Immunity to irrational exuberance - which of course translates here into the willingness to contemplate disaster. The core is the social aspect, though.

Posted by: roquelaure_79 | April 7, 2010 11:54 AM | Report abuse

You don't suppose the real they stopped the Conrad-Gregg commission because it gave all the power to make those decisions to the committee, and not to Congress, do you?

Not that I don't trust Pete Peterson to do what's best for the country, of course! After all, if the Post thinks enough to run everything he says as gospel, who am I to argue?

Posted by: uberblonde1 | April 7, 2010 11:57 AM | Report abuse

Disasters do happen.

To deny that is lunacy.

People who warned of a housing bubble and financial collapse were labelled as conspiracy theorists.

The problem is figuring out which threats are real and which are not. Americans are ill-prepared to judge because our politicians are clowns and the western media is a circus with a set agenda.

Posted by: Lomillialor | April 7, 2010 12:05 PM | Report abuse

It seems like individually people tend to overestimate the likelihood of a catastrophic event, such as being the victim of a terrorist attack or a plane crash.

Its odd that large aggregate groups of people would underestimate catastrophic events.

Posted by: dreyno85 | April 7, 2010 12:14 PM | Report abuse

Anyone with half a brain could see that house prices were going up at a unbelievable rate for no reason.

Posted by: obrier2 | April 7, 2010 12:32 PM | Report abuse

It's amusing how Klein and others expose their bias by their use of the "subprime market" as opposed to the "housing bubble".

I believe NN Taleb has you covered here. Some of the chapters he has been adding onto the Black Swan are amazing, particularly on the ideas of robustness.

"Over the past twenty-five hundred years of recorded ideas, only fools and Platonists (or, worse, the species called central bankers) have believed in engineered utopias. We will see...that the idea is not to correct mistakes and eliminate randomness from social and economic life through monetary policy, subsidies, and so on. The idea is simply to let human mistakes and miscalculations remain confined, and to prevent their spreading through the system, as Mother Nature does. Reducing volatility and ordinary randomness increases exposure to Black Swans—it creates an artificial quiet."

Posted by: staticvars | April 7, 2010 12:47 PM | Report abuse

Try this one on: Ubiquity - Why Catastrophes Happen, by Mark Buchanan, Three Rivers Press, NY. 2000.

Posted by: Wishram | April 7, 2010 1:40 PM | Report abuse

The Big One hits California. Or an area which doesn't have building codes for earthquakes. Or a disease hits one of the key crops which are grown as a monoculture (rust in wheat). Cat 5 hurricane returns to New Orleans.

Posted by: bharshaw | April 7, 2010 2:50 PM | Report abuse

Economies cannot grow forever on a planet with finite resource flows. Our financial system is just beginning to encounter that fact. Because our system of lending money into existence depends on greater and greater debt and growth over time, it WILL eventually be replaced or collapse.

Several strategic resources are simultaneously being tested near their limits... oil and water being the most evident, but soils, fisheries, rock phosphate, and others are near full utilization.

Our global civilization will face collapse in some places, unevenly, and already is. You have to be in denial not to see it.

Posted by: billSWS | April 7, 2010 4:46 PM | Report abuse

Nuclear power plants won't ever melt down. The human species will find something to do with their waste, forever. Nations will never use the bomb. ... there are some almost inevitable disasters waiting to happen that anyone who looks knows about; so very few look.

Posted by: janinsanfran | April 7, 2010 7:08 PM | Report abuse

Other looming catastrophes:
#1 population growth, even if we find an energy alternative to oil, we're on a Malthusian path. Soon available resources will be insufficient.

#2 Ocean pollution, our breathable atmosphere is a product of livable oceans. At some point we're going to reach a threshold where phytoplankton begin to die en-mass.

#3 On the long term Earth will not be indefinitely habitable. If we don't eventually create the means to get out of here, all species will become extinct. Earth will become uninhabitable when the sun leaves the main phase, but it might happen much sooner.
A. We might be hit by a big space rock.
B. A super volcano could erupt.
C. A nearby star could go supernova(or have gone supernova the radiation takes a long time to travel)

Posted by: zosima | April 7, 2010 9:48 PM | Report abuse

On my #3
I should add that although these things seem completely outside the realm of human experience and incredibly improbable, looking through a telescope shows us that these events are fairly common. There is a planet sized volcano on Mars. We saw Shoemaker-Levy hit Jupiter starting in 1994. Supernovae occur about once every 50 years in our galaxy.

Posted by: zosima | April 7, 2010 10:02 PM | Report abuse

This seems to me like a red herring: "The obvious place is the federal debt. It's trite to say the trend is unsustainable. And it's hard to look at recent political history and say we're capable of making a radical adjustment. But that's definitely what the numbers suggest. This is something that a lot of people in Washington (and in the country more broadly) recognize in theory, but that theoretical understanding hasn't translated into the sort of practical urgency you'd expect."

A mere decade ago, the debate was over how to deal with the consequences of eliminating the federal debt altogether. What I read is that the bad consequences of too much federal debt is too high interest rates and too much inflation. Neither sky high interest rates nor hyperinflation appear to be likely any time soon, so there is no reason for a sense of urgency on this issue.

When we have an economy that is moving forward at a rate that starts producing significant job growth, then we be in a position to see what the long term trends are and take some measures to bring the budget into balance and perhaps even emulate Bill Clinton and produce a surplus.

The argument on behalf of the recently passed HCR is that it will make a start on getting our health care costs under control and reduce spending in the long term. Turning war spending down is another step in that direction.

Recent political history--especially the eight years of Bush/Cheney--is no guide to the future. Non-radical, incremental adjustments can make a big difference over the long haul, and since what deficit doomsayers are worried about is the long haul, this is, in the scheme of things, a manageable problem.

I'm not saying that the deficit couldn't turn into a catastrophe. But what would turn it into a catastrophe is an irreversible downward spiral in the US economy combined with Bush/Cheney style mismanagement. The Obama administration seems exquisitely tuned to the dangers of the federal deficit and if anything, too eager to throttle the economy in the name of reducing the deficit. The Eurozone has apparently brought their growth to a standstill thanks to that policy; hopefully, the Obama administration will not go down that path.

Posted by: remarksdc | April 8, 2010 1:10 AM | Report abuse

I see Mt Klein is still claiming that the global warming "scientific consesnus", indded the entire scare story, is real. Yesterday I asked him to name 2 scientists independent of government who support this catastrophe claim. If it is a genuine honest consensus he should be able to name several hundred thousand of them. I repeat my challenge for him to manage 2.

Posted by: NeilCraig | April 8, 2010 8:30 AM | Report abuse

I'd nominate the whole Tea Party phenomenon. They see the world about them dangerously changing, with threats and conspiracy in every direction, from a Black, Muslim, non-American President to secular Antichrists teaching Darwin instead of Genesis. It takes a massive suspension of rationality to conjure up their mindset.

Posted by: tomcammarata | April 8, 2010 8:28 PM | Report abuse

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