Earthquakes and Hurricanes: An essay on normalcy and the unexpected
Part 1: Double Whammy: Tuesday the earthquake and Saturday Hurricane Irene. Monday and the power is still off. The 5.8 magnitude earthquake alone spurred me to think about big and unexpected events. Who would have predicted that these two events would happen a few days apart.
The Quake: On Tuesday (August 23) at about 2:00 PM my house shook nearly knocking me over. I ran outside. My initial reaction was a combination of fear and extreme disorientation and disbelief. Friends experienced similar feelings. Phone lines were jammed.Washington government and office buildings were evacuated. People swarmed in the streets. The upper part of theWashingtonMonument received a good sized crack. Fortunately not many injuries. Things were a lot worse close to the epicenter near Mineral,Virginia. See photos. The North Anna Nuclear Power station lost electrical power and had to be shut down due to the quake’s vibrations. Geologists and seismologists were caught off guard. An earthquake with a 5.9 magnitude is extremely rare in the Mid-Atlantic. Nothing like this happened for the past 100 years.
Irene: A lot more damage. Hundreds of thousands up and down the east coast lost power. The worst flooding in decades in Vermont. More than 30 people killed. Michelle Bachmann told her Florida audience that the two events are a warning from God. Former Senator George McGovern replied on Diane Rehm; “I don’t believe in a God who would kill to send a message.”
Out of the ordinary: Like most people I don’t like big surprises, especially those that strike with a vengeance – ones that lie outside of the realm of normalcy. A giant oak stands for a hundred years suddenly falls and crushes the back of a house. A friend suddenly dies of a heart attack. Much better not to think about these possibilities not to mention our own mortality; we exist and then in an instant we don’t. Much better to stick to routine – brewing the morning coffee, scanning emails – I personally like cleaning the kitchen – brings reassurance that “the natural order of things” can be restored quickly. Or can they? Ask the Japanese. Ask those who suddenly lost jobs they held for years and the many who lost their homes.
Part 2: Black Swans: Recently, many of the norms we believe in are being blown away. We here terms like “tipping point,” and “new normals” and “systemic instability.” In his 2007 best seller, The Black Swan, Naseem Nicholas Taleb, a major league investor warned of an impending financial collapse. Taleb was one of the few experts that understood that wealth built on a housing bubble and mortgage-backed securities was vulnerable. The term black swan? Black swan events are infrequent, difficult to predict, beyond the realm of expectation and cause havoc. The once in a hundred-year earthquake is an example (fortunately the damage was limited). The name black swan? Europeans until several hundred years ago assumed that all swans were white. This changed when the first Dutch explorers arrived inAustralia and saw black swans galore.
Cascades of failure: Taleb’s warnings proved all too true. In the fall of 2008 Wall Street suddenly teetered and only trillions in federal bailout funding prevented total collapse. By examining how this came about, we can learn a great deal
about the behavior of complex systems. The meltdown was initially triggered by a precipitous drop in the value of housing that occurred as a response to a rapid rise foreclosure rates (2006-2007). But it didn’t end there. Highly risky sub-prime mortgages were bundled with other supposedly less risky loans; the bundles were sold as “securities” which received triple-A grades from Standard and Poors and the other rating firms. These “mortgaged-backed securities” began to tank in 2007. But it gets worse. Many big market players held “credit default swaps” – arrangements in which the investors pay monthly “insurance” premiums to firms like AIG. The terms: if the value of the covered product (e.g. a stock, a future, a market index) falls to a certain point, the insurance provider must pay the claims specified in the agreement. Unlike homeowner who buys fire insurance, the party who purchases a credit default swap (CDS) doesn’t have to own the asset covered in the deal. Many were simply bets. These deals amounted to trillions of dollars that were neither regulated nor transparent. (You may recall the AIG commercial showing the little boy who comes into his parents in the middle of the night worrying about the family’s financial security. “Don’t worry, we’re with AIG” says the Dad a few months before the crash. (See video).
Remember too-big-to-fail? In mid-September 2008 AIG, the dominant CDS insurer, was forced to payout tens of billions of dollars to settle these claims – and the company’s stock lost 60 percent of its value overnight. On September 16th the federal government intervened by loaning AIG $85 billion to keep it afloat. AIG was simply “too-big-to-fail.” Administration officials believed that AIG’s fall would have created a collapse of the entire economic system. But did the regulators know that they were dealing with a financial house of cards? Or did they buy into the prevailing wisdom – bubbles last forever? And how much has changed? Thanks to trillions in government bailouts the Wall Street giants recovered nicely. However, while refusing to loan to small (job creating) businesses, the Goldman’s and Banks of America had no reluctance to buy other banks. After all, if they crashed again Uncle Sam would come to their rescue; after all they are now even “bigger-too-big-to- fails.” With many of Europe’s economies in trouble and Wall Street giants Bank of America and Goldman Sachs loosing ground, are we in danger of a second round of failure and bailout? Hear the Diane Rehm Show of August 30 for a great discussion on the current state of banking.
Complex systems: Economies, ecosystems, the earth’s atmosphere are all examples complex systems — systems characterized by lots of interconnected parts. In such a system the whole is greater than the sum of the parts because interactions and processes dominate. Such systems are difficult to understand and cannot be done so in the classical way – dissecting the parts. Tipping points, black swans, vicious cycles and cascading failures are all indications that a complex system is highly unstable and subject to large fluctuations – relatively small disturbances tend to create mega-changes. The financial meltdown a case in point.
Hurricanes illustrate the effects of instability. They occur in the late summer and early fall because ocean surface temperatures are highest — a condition that loads the atmosphere with water vapor and favors strong overturning of the atmosphere. Both effects contribute to the growth and fury of hurricanes. “Climate change deniers” notwithstanding, global warming means warmer oceans and more frequent and intense hurricanes and greater extremes.
Resilience: Not all complex systems are vulnerable. As we’ve pointed out in previous posts, ecosystems (in their native state) tend to be resilient. They have mechanisms that allow such systems to absorb disturbances and adapt to changes (droughts, infestations, floods) without collapse. The great biodiversity of nature ensures that some flora and fauna will survive the next forest fire or spring freeze. Nature’s decentralized renewable energy system and continual investment in restoration also contribute to resilience. Unfortunately, our globally intertwined socio-economic systems tend to be vulnerable rather than resilient. There are many reasons for the fragility, including: speed of light transfer of capital, financial consolidation consuming diversity, a growing wealth gap between the wealthy (creates instability and political unrest) and the rest of us. Future posts will focus on the theme of building resilience into economies – from the bottom up.