Legal Commentary

British Petroleum?s drilling accident in the Gulf of Mexico this past April is the latest of several recent disastrous events for which the country, or the world, was unprepared. Setting aside terrorist attacks, where the element of surprise is part of the plan, that still leaves the Indian Ocean tsunami of 2004, Hurricane Katrina in 2005, the global economic crisis that began in 2008 (and has been aggravated by Greece's recent financial collapse), and the earthquake in Haiti last year.

The reaction to the latest accident has been surprising. Oil spills and underwater drilling accidents are common, and despite the media hype it is too soon to tell whether this one will prove to be the biggest yet. The amount of oil leaked so far is substantially less than the amount spilled or leaked in previous accidents, including at least one in the Gulf of Mexico.

It is also surprising that so much criticism has been directed at the Obama Administration, and indeed against Obama personally. Most of the criticism is absurd?his failure to react emotionally, and his inability to ?just plug the hole,? are not personal or professional failings. The Minerals Management Service in the Department of Interior does seem to have been asleep at the switch, but Obama unlike his immediate predecessor cannot be criticized as being hostile to regulation?if anything, he has too much faith in it. MMS is a small and obscure agency far below the horizon of a president?s supervision. No president can eliminate all pockets of incompetence in the vast federal government.

It is possible that the number of recent disasters has created a public sense that something is wrong with government: that it ought to be able to prevent all disasters. But this is an unrealistic expectation. Everything conspires against a government?s being able to protect its people against disasters, whether natural or man-made. A factor that retards prevention of man-made disasters is the rapid and relentless advance of technology. Regulation lags innovation. The Federal Reserve, Treasury Department, and SEC were no more able to keep abreast of advances in financial engineering than MMS was to keep abreast of advances in drilling for oil at very great depths under water. Slack regulation encourages private companies to adopt a high-risk business model. Risk and return tend to be positively correlated, in finance because risky loans command higher interest rates and in underwater drilling because risk abatement is costly. Business is particularly reluctant to take preventive measures against unlikely disasters because they do not pose a serious near-term threat. If there is a 1 percent annual probability of a disastrous drilling accident or financial collapse, the probability that the disaster will occur any time in the next 10 years is only 10 percent. Business managers have finite planning horizons just like politicians.

Of course, if the consequences of a disaster would be very grave, the fact that the risk is low is not a good reason to ignore it. But there is a natural tendency to postpone taking costly preventive action against dangers that are only 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, if the probability and often the consequences of disaster cannot be estimated with any confidence, if remediation after the fact seems like a feasible alternative to preventing disaster in the first place?and because there is so much else to do in the here and now than worry about remote eventualities. The overcautious business will lose profits, investors, and staff to its bolder competitors; the overcautious regulator will be harassed by politicians pressured by business, labor, and other interest groups.

All the factors that I?ve identified came together to enable 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 suffice 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 for policy; 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, and this in turn discouraged the appointed officials of the Federal Reserve and other regulatory agencies from taking such measures. Finally, with no reliable probability estimate of a financial collapse available, it seemed prudent to wait and see, hoping that with the passage of time at least some of the uncertainty about risks to the economy would dissipate.

The BP oil leak reveals a similar pattern, though not an identical one. One difference is that the companies involved must have known that in the event of an accident on a deepwater rig prompt and effective remedies for an oil leak would be unlikely?meaning that there was no reliable alternative to preventing an accident. But the risk of such an accident could not be quantified, and it was believed to be low because there hadn't been many serious accidents involved in deepwater drilling. (No one knew how low; the claim by BP chief executive Tony Hayward that the chance of such an accident was "one in a million" was simply a shorthand way of saying that the company assumed the risk was very small.)

But other causal factors were similar in the leak and the financial crisis. If deepwater oil drilling had been forbidden or greatly curtailed, the sacrifice of corporate profits and of consumer welfare (which is dependent on low gasoline prices) would have been great. Elected representatives did not want to shut down deepwater drilling over an uncertain risk of a disastrous spill, and this reluctance doubtless influenced the response (or lack of it) of the civil servants who do the regulating.

The horizon of the private actors was foreshortened as well. Stockholders often don't worry about the risks taken by the firms in which they invest, because by holding a diversified portfolio of stocks and other financial assets an investor can largely insulate himself from risks taken by any particular firm. Managers worry more about the fate of their company because they often are heavily invested in it terms both of human capital and of reputation. But they rarely are held personally liable for the debts of the firms they oversee and, more important, the danger to their own livelihood posed by seemingly small risks is not enough to discourage risk-taking.

Two final problems illuminate the nation?s vulnerability to disasters. First, it is very hard for anyone to get credit for preventing a low-probability disaster. Because such a disaster was unlikely to occur, the benefits of taking action beforehand could not be assessed unless the preventive action took the form of a dramatic last-minute save. Had the Federal Reserve raised interest rates in the early 2000s rather than lowering them, it might have averted the financial collapse in 2008 and the ensuing global economic crisis. But we wouldn't have known that. All that people would have seen was a recession brought on by high interest rates. Officials bear the political costs of preventive measures but do not usually reap the rewards.

The second problem is that there are so many risks of disaster that they can't all be addressed without bankrupting the world many times over. In fact, they can?t even be anticipated. In my 2004 book Catastrophe: Risk and Response, I discussed a number of disaster possibilities. Yet I did not consider volcanic eruptions, earthquakes, or financial bubbles, simply because none of those seemed likely to precipitate catastrophes.

It would be nice to be able to draw up a complete list of disaster possibilities, rank them by expected cost, decide how much we want to spend on preventing each one, and proceed down the list until the total cost of prevention equals the total expected cost averted. But that isn't feasible. Many of the probabilities are unknown. The consequences are unknown. The costs of prevention and remediation are unknown. And anyway, governments won't focus on remote possibilities, however ominous in expected-cost terms. A politician who proposed a campaign of preventing asteroid collisions with Earth, for example, would be ridiculed and probably voted out of office.