A Perennial Risk Problem

Cash strapped Detroit recently announced it won't be responding to home alarms: 99% of them are false. A naive risk solution is to itemize everything that can go wrong, but in doing so it is as bad as not mentioning any risks: moderation in all things, in this case, the perennial balance between type 1 and type 2 errors. Hyperactive risk reports have the benefit of rarely being 'wrong', just not useful, because after a short while decision makers get used to ignoring these risks. I remember the first time I bought a house, and didn't know what to look for in the inspection. I hired someone to do this for me and for a couple hundred bucks I got a list of over 100 items that were not prioritized, which I found totally unhelpful, but I had to pay him (he obviously did work).



The 1986 Challenger Space Shuttle disaster was a great example. No fewer than 748 parts were designated 'Criticality 1', meaning they violated NASA's redundancy criterion: if they failed the shuttle would be lost. In the first 25 flights up through its last, 131 technical flows proved serious enough to warrant NASA's designation of 'launch constraint.' Of these, 66 were resolved after 1 flight, the rest, like the O-ring joint that ultimately failed, overridden repeatedly. If there are that many high level risks going off, that's what happens.



Real risk reports prioritize risks in a way proportional to their expected damage: probability times cost. Many times these probabilities are so small, they are rather qualitative, but such is risk. Nonetheless, Detroit reminds us that merely saying anything or everything can go wrong, while true, is quite useless and not profound. Enumerating a long list of disparate things that may happen, without any probabilities, may work for Nouriel Roubini, but he's a charlatan: here he is last week taking credit for his client switching to cash a couple months ago, he doesn't mention he has been suggesting investors go to cash since 1990, always for a slew of reasons (though Lawrence Summers is here giving props to Roub for calling the housing crisis). I have seen reports that endlessly enumerate risks many times in large corporations, and they are highly correlated with people who either are too afraid to make a mistake, or profoundly do not understand their job.