Yesterday (Part 1), we discussed why we need risk assessment- and alluded to why we fail this process.  We really do not understand risk, at all. The chance that a nuclear reactor will experience catastrophic failure in any given year is pretty low; but the probability of a nuclear accident happening anywhere is much higher.  The same is true when one considers a terrorist attack or even possibility of another BP oil spill.  And, the wild card in every calculation is human error (or stupidity).

The BP fiasco is not just a problem with BP.  It includes actions (or inactions) of TransOcean and Halliburton.  Each made short-term decisions that were only of interest to them.  They did not assess what these decisions would have upon the other actors. BP cut out the remote switch to turn off the rig.  (OK, that was afforded them by the US Department of Interior operating under rules of engagement (disengagement?) decided by Dick Cheney (previously of Halliburton). Halliburton used cementing practices that are/were supposed to prevent oil and gas seepage from well pipes; instead it is the primary or secondary cause of 50% of the blowouts in the Gulf of Mexico.  TransOcean rented the rig and provided the people (tired, insufficient) that did not react to the leak occurring before the explosion and fire. The Material Management Service (US Department of Interior) failed in its obligation to regulate these three actors.

This same phenomenon prevailed for our financial (derivates and mortgage banking) crises. This, the collateralized debt obligation fiasco came about for two reasons- the failure to have a regulating authority operate in an intelligent fashion (since private industry rarely will examine all public interests in an objective fashion) and an industry focused on maximizing short term profits (at the expense of long term profits).

To complicate matters, it’s not just the disasters we have to worry about- it’s the near misses. The Times Square bomber (or almost bomber) was clearly a near miss.  What are we doing to stop them?  (I want to bring your attention to the very commendable actions of the New York City Police that probably prevented another grand disaster when they arrested the two youths trying to become Somalian terrorists.  There are changes to the risk profile being done at some levels of government.)

Some of you are saying right now that we don’t need governmental regulation of companies.  It’s unnecessary.  Well, in a nutshell- you are wrong.  Risk management in private industry is a cost center; the powers that be in these firms are always trying to minimize the expenses in cost centers.  As such, these risk assessment units are not usually populated with the best and brightest.  Topping that off, the compensation system does not reward them properly, so our best and brightest mathematicians and economists (this is sophisticated analysis, after all) do not examine said pathways

We need to change our compensation systems (and the stock market) from ONLY focusing on short terms results- this quarter and next quarter.  One of the only groups I have seen direct their attention to long term profits are venture capitalists- and that is because they understand there are no short term profits to maximize.

We need to determine the potential causes of failure- and preclude their occurrence.  But that means we really do it.  After the Valdez Oil spill, we passed a law ensuring that we would have the plans, means, equipment, and people to handle a new spill.  Where were they for this disaster?

The economic costs associated with the next petroleum fiasco, nuclear power plant, or terrorist event will be significantly larger than the investment necessary to preclude its occurrence- but that does not mean we will spend the money or devote our attention.  Don’t believe it- think about our (very, very current) history as to how we are dealing with our bridge safety issues!

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