Tuesday, June 8, 2010

Under Regulation Has Brought Us To This

The Republicans are fond of saying that they don't like "Big Government" and they don't want the government in every aspect of American life. What they really mean is that they don't want the government involved in American business life. In their minds, the free market ought to be able to do what it wants and everything else will take care of itself. The only thing wrong with this is that human beings, flawed as we are, are greedy, dishonest, and not too trustworthy when we are not being watched.

An intriguing aspect of the BP oil spill is that, before the accident, deep water drilling seemed to be a technological triumph. About 80% of the Gulf of Mexico's recent oil production has come from this kind of deep water operation, defined as water depths exceeding 1,000 feet. In 1996, it was 20%. Jack-up rigs, which are oil platforms on stilts in a few hundred feet of water, have given way to the Mobile Offshore Drilling Unit (MODU). It keeps its position through the interaction of global positioning satellites and on-board engines that activate directional propellers to offset ocean currents and wind.

Seismology and submersible robotic technology have also advanced. The Deep Water Horizon rig was not testing new limits. It was drilling in about 5,000 feet of water, whereas others have approached 10,000 feet. The safety record was good. The American Petroleum Institute, the industry's main trade group, says that since 1947, oil companies have drilled more than 42,000 wells in the Gulf of Mexico and recovered about 16.5 billion barrels of oil. Against that, spills totaled about 176,000 barrels from 1969 to 2007. In a typical year, it was a few hundred barrels. By contrast, recent production is about 1.6 million barrels a day.

Cost-cutting by BP, careless rig operators, and lax regulators have all been fingered as plausible culprits in the blowout. President Barack Obama has appointed a commission to investigate the causes and the Justice Department has launched a criminal investigation. There will be extensive analysis, I'm sure. But the stark contrast between the disaster's magnitude and the previous safety record points to another perverse possibility: The success of deep water drilling led to failure. It sowed overconfidence. Continuing achievements obscured the dangers. Once again, deregulation and the absence of strong government controls is the culprit.

This pattern applies to other national setbacks. Consider the financial crisis. It was not the inherent complexity of sub-prime mortgages or collateralized debt obligations (CDOs) that caused the crisis. It was the willingness of presumably sophisticated investors to hold these securities while ignoring the complexity and underlying risks. This behavior was understandable at the time... understandable then, but foolish now.

The economy seemed to have become less risky. High inflation had been suppressed. Since 1982, there had been only two relatively mild recessions, from 1990 to 1991 and again in 2001. Economists talked of the "Great Moderation." The stock, bond, and foreign-exchange markets had become less volatile. Day-to-day price movements were smaller and less erratic. One study of the 2004–2006 period found that stock-market volatility in seven advanced countries had dropped about a third from historical averages and that bond-market volatility was down almost a fifth.

So, it stands to reason that, if the economy and markets had become less risky, traders and investors could take what once would have seemed greater risks to increase profits. They did and they created new vulnerabilities for markets and the economy. The belief that past economic and financial instability had been quelled encouraged future instability and foolhardiness.

Or, take the recent Toyota car scandal. Few auto companies enjoyed as envious a reputation. Although I'm a Nissan man myself, Toyota consistently did well in surveys of reliability and customer satisfaction. This success, as well as the resulting image inside the company and among government officials, helps explain why Toyota reacted so slowly to problems with its accelerators and why government officials were not as assertive as they should have been. Problems were minimized because they seemed out of character for Toyota. Do you see the pattern here?

One theory of the oil spill is that the deep water technology is inherently so complex and dangerous that it can't really be understood or regulated. The safety record before the BP spill seems to rebut that. The problem is that the system broke down so, let's just admit that, okay? Careless mistakes were made or regulators were co-opted by industry and paid to look the other way or not look at all. Judgments were botched... something the post-crisis investigations will presumably fill out in the final story. Still, they may miss the larger question of why.

Nobody has yet suggested that the blowout reflected a previously unknown geological phenomenon, something in the oil formation, or a quirk of technology that no one could have anticipated. Perhaps studies will reveal one or the other. But, the prevailing assumption is that this accident was preventable, meaning that human error was responsible.

There's a cycle to our calamities or at any rate, some of them. Success tends to breed carelessness and complacency. People take more risks because they don't think they're taking risks. The regulated and the regulators often react similarly because they've shared similar experiences. The financial crisis didn't occur so much because regulation was absent (many major financial institutions were regulated), but because regulators didn't grasp the dangers. They, too, were conditioned by belief in the Great Moderation and lower financial volatility. It is human nature to celebrate success by relaxing. The challenge we face is how to acknowledge this urge without being duped by it.

In relaxing, we can't make the mistake of becoming lax! But oh, we've already done that... and now, we have to pay the price for our laxness and our deregulation of damn near everything.


The Brown Blogger said...

There it is.

Well said.

Rich Fitzgerald said...

Great pulling together of the facts. I just did a small post concerning this oil problem we're having. I think you'll find it "interesting".


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