I didn’t have time to blog today, so here are some interesting posts that relate to issues I’ve been discussing.

James Hamilton on the implications of the oil spill:

I agree with Ed [Dolan] that intra-organizational incentives contributed to the problem in both cases, and that government policy allowed the firms that created the problems to pass some of the costs on to others in many details of the financial debacle. But I am less persuaded that limited liability explains BP’s decisions at the corporate level. The company’s market value has declined by over $75 billion since April. Here was an entity with more than just skin in the game and looking more than just flayed at the moment. And yet, the company opted not to invest $500,000 in a secondary acoustic shut-off switch, which is essentially required in Norway and Brazil, and which Royal Dutch Shell and France’s Total SA sometimes use even when not required. BP’s backup plans B, C, and D all seemed to come out of the playbook for dealing with the 1979 Ixtoc disaster— none of them worked that well there, either. So why did the company take such risks?

I think part of the answer, for both toxic assets and toxic oil, has to do with a kind of groupthink that can take over among the smart folks who are supposed to be evaluating these risks. It’s so hard to be the one raising the possibility that real estate prices could decline nationally by 25% when it’s never happened before and all the guys who say it won’t are making money hand over fist. And this interacts with the forces mentioned above. When the probability of spectacular failure appears remote, and moreover it hasn’t happened yet, it’s hard to set up incentives, whether you’re talking about a corporation or a regulatory body, in which the person who makes sure that the risks stay contained is the person who gets rewarded. When everyone around you starts thinking that nothing can go wrong, it’s hard for you not to do the same. It can become awfully lonely in those environments to try to be the voice of prudence.

And yet, prudent judgment is the thing I most desperately wish decision-makers had more of in these times of dazzling new technological capabilities.

That was the point I was trying to make, but Hamilton makes it much more eloquently.  Here is Ryan Avent:

After having a look at the Fed’s new Beige Book and at Ben Bernanke’s testimony to Congress, it’s impressive the extent to which the Fed acknowledges the economic headwinds facing the economy, only to basically repeat the forecast it’s been touting (with small nudges one way or another) for the past nine months””American economic growth of between 3% and 4% this year and next, settling down thereafter. I’m not sure if that’s reassuring or troubling.

The whole post is worth reading, but I’d like to comment on why I think the Fed’s view is troubling.  Given the current inflation rate of 1%, the Fed is essentially forecasting 4.5% NGDP growth as far as the eye can see.  That’s trend growth, if we assume that trend real GDP growth has fallen to 2.5% (a widely held view.)  OK, so what does trend NGDP growth mean?  It means the Fed is contributing nothing to the economic recovery.  AD expansion is at rates you’d expect if we were at full employment.  The entire recovery must be “financed” by below trend inflation.  Alternatively, by shifts in the SRAS curve due to wage and price cuts.  And recall that NGDP recently fell nearly 8% below trend.  Even if half that was a permanent real shock, surely with 9.7% unemployment there must be some slack?  Couldn’t the Fed just help us out a little bit?  A tiny bit?  Is there really nothing they can do?

Here is Tim Duy:

To summarize, the Fed believes we are facing another threat to demand, either via financial or real trade linkages, at a time when lending activity continues to fall, suggesting that monetary policy is too tight to begin with.  But the Fed stance is to believe that monetary policy is on the verge of being too loose, and, if anything, planning needs to be made to tighten policy.  At the same time, Fed policymakers also believe fiscal policy needs to turn toward tightening as well. Meanwhile, unemployment hovers just below 10%, nor is it expected to decline rapidly,  and inflation continues to trend downward.

All of which together suggests that the Fed’s policy stance is seriously out of whack with policymaker’s interpretation of actual and potential economic developments.  And I have trouble explaining the disconnect.

As I read Duy’s entire post, I tried to imagine what a Fed official might say in their defense.  Usually I can do that, even when reading something with which I disagree.  For instance, people often send me Krugman articles they object to.  Even when I agree with Krugman, I can usually imagine how he could defend his argument against a critique.  Tim Duy’s post seemed so persuasive that I can even imagine a credible counterargument.

Arnold Kling has some of his usual excellent posts on the housing crisis (here and here.)  I learned that my anti-Fannie and Freddie views are considered racist among some members of the liberal elite.  Ah yes, the racism accusation.  The McCarthyism of the left.  My reaction?  Only a left-wing  pinko commie would make that kind of accusation.

BTW, the McCarthy era was already ancient history by the time I was a teenager in 1970.  I have to think we are rapidly approaching the time when people who recklessly throw out the charge of “racism” will look just as silly as those who accuse Obama of being a communist.

Several people have asked me to comment about the oil spill.  Obviously I am not really qualified—but when has that stopped me before?

Other bloggers have already expressed some of these views, but for what it’s worth here’s my take on things.

1.  BP stock has fallen quite a bit.  I don’t know how much, but I assume their losses are in the $10s of billions.

2.  The environmental damage in massive, probably in the $10s of billions.

3.   BP and the firms they hire are very technically sophisticated.  They probably know as much about how to prevent these accidents as anyone else.

4.  It’s been widely noted that people and institutions become complacent about risks when accidents haven’t happened for a long time.  People have pointed to the Titanic, Three Mile Island, the Challenger, and other similar accidents.

So where do we go from here?  The knee-jerk reaction in Washington and among more liberal economists is “more regulation.”  I don’t have any problem with that view in principle; (I favor government attempts to address externalities) but I just don’t see how the facts match the proposed solution.  It seems to me that there are two possibilities, neither of which call for regulation:

1.  The financial losses to BP are the same order of magnitude as the damage to the environment.

2.  The damage to the environment is an order of magnitude or more bigger than the losses to BP.

In case one it seems to me that we need to simply accept the fact that “stuff happens.”  And hope this will be a wake-up call for the offshore oil drilling industry to be more careful.  In case 2, I think we should just throw in the towel and give up on off-shore drilling.  Or perhaps give up on it in the bigger and deeper wells that are potentially so damaging.  (I assume that smaller wells in shallow water are easier to cap.)  My hunch is that case one is more plausible, but I have an open mind.

I just don’t see an in between case where regulation can do much good.  The oil companies already have a strong incentive to avoid these problems, and the engineers in the oil industry are extremely talented, probably more so than those who would be regulating them.  So it really comes down to a simple issue: is this a “market failure” where incentives are way out of line, or just the sort of really bad event that occasionally happens.  If there is a market failure here, I’d say shut down all the wells that are potentially this dangerous, don’t even waste time on regulation.

By this point my liberal critics have given up reading and are scrambling to write posts about how clueless those Chicago economists are in their reflex opposition to regulation.  But you know I always like to tack on something unexpected, like an O’Henry story.  So here it is:

The lesson of the BP fiasco is that we don’t need more regulation of off-shore drilling, but we do need more regulation of electrical power and biotech.  More specifically, we need the government to start strategizing about what to do if there is a massive solar flare that wipes out the power grid east of the Mississippi for months on end.  Or what happens if Craig Venter’s evil twin develops a deadly virus that spreads like the common cold.  If we are to have more regulations, I’d rather we have our regulators think about the time bombs that everyone is ignoring, rather than problems that the oil companies are probably already hard at work addressing.

What would that regulation do?  I don’t know.  Perhaps send more satellites into space to warn us of solar flares.  Of more dress rehearsals of shutting down the electrical grid if there is one.  Or stockpile transformers.  For bio-tech we might want to divert some of the money used on research to cure diseases, into research on how to prevent man-made plagues.  Perhaps we could stockpile vaccines that might offer limited protection against certain types of plagues.  Again, this isn’t my area, but from articles I’ve read we seem woefully unprepared for crises that would be 100 times worse than this oil slick.  I used to assume that the government had some sort of secret agency of geniuses that strategized all these dangerous possibilities, like in James Bond movies or Mission Impossible.  But I outgrew that naivete years ago.

I suppose it is more fun to bash the oil industry than think about two billion people dying from a human engineered plague.  But perhaps it’s time we stopped going with our gut, and started thinking more rationally about the dangers that our high technology society seems to be rushing toward with little forethought.

Stuff happens?  Yes, and maybe that means we are overreacting to the oil spill.  But that’s not what worries me.  Even if increased regulation of oil drilling does no good, it also does comparatively little harm.  What worries me is the “stuff” that may happen in areas that we don’t even seem to be thinking about.  Areas where we can’t afford a single accident.