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From Oil Spills To Financial Crises — Why We Don’t Plan For The Worst

Two reasons we’re vulnerable to low-probability but highly catastrophic risks: 1) it’s very hard to reward someone for preventing a low-probability disaster; 2) there are so many of these risks, and they often end in acceptable outcomes (i.e., non catastrophic), that we’d go bankrupt trying to prevent them all.

… In all these cases, observers recognized the existence of catastrophic risk but deemed it to be small. Many other risks like this are lying in wait, whether a lethal flu epidemic, widespread extinctions, nuclear accidents, abrupt global warming that causes a sudden and catastrophic rise in sea levels, or a collision with an asteroid.

Why are we so ill prepared for these disasters?

…Of course, if the consequences of the disaster would be very grave, the fact that the risk is low is hardly a good reason to ignore it. But there is a natural tendency to postpone preventive action against dangers that are likely to occur at some uncertain point in the future (“sufficient unto the day is the evil thereof,” as the Bible says), especially if prevention is expensive, and especially because there is so much else to do in the here and now.

Our tendency to procrastinate is aggravated by three additional circumstances: when fixing things after the fact seems like a feasible alternative to preventing disaster in the first place; when the people responsible have a short time horizon; and when the risk is uncertain in the sense that no objective probability can be attached to it.

All these forces came together to permit the economic crisis, despite abundant warnings from reputable sources, including economists and financial journalists. Risky financial practices were highly profitable, and giving them up would have been costly to financial firms and their executives and shareholders. The Federal Reserve and most academic economists believed incorrectly that in the event of a crash, remedial measures — such as cutting interest rates — would be enough to jump-start the economy. Meanwhile, depending on how they were compensated, many financial executives had a limited horizon; they were not worried about a collapse years down the road because they expected to be securely wealthy by then. Similarly, elected officials have short time horizons; with the risk of a financial collapse believed to be low, and therefore a meltdown unlikely in the immediate future, they had little incentive to push for costly preventive measures.

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Still curious? Read Catastrophe: Risk and Response.