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BP Oil Blowout And "Flash Crash" Lessons

11 May 2010
Posted by Pete Davis
At 9:45 p.m. CDT April 20, the BP Deepwater Horizon oil platform exploded in fire, and at 2:45 p.m. EDT May 6 the Dow dropped 1,010 points. The Senate Energy Committee grilled oil executives this morning, and House Financial Service grilled regulators and exchange officials this afternoon. What did we learn from this?
 
  1. We're not sure what happened. Automatic systems failed in the Gulf, and automatic computer equity trading systems spun out of control, but, so far, the exact causes are not known.

  2. Nobody is to blame despite heavy losses imposed on innocent victims.

  3. Somebody is going to have to clean up these messes, probably at taxpayer expense.
 I would recommend:

  1. Better monitoring and inspection of automatic systems the failure of which can impose large costs if they fail. Just like cameras in a bank, a lot can be learned after the fact. There were no sensors down this well, and computer trading is too spread out to easily pinpoint the origin of the "flash crash."

  2. That when the government authorizes offshore drilling, fails to insure orderly markets, and authorizes other activities that put the public at risk it should react quickly to prevent any failures from recurring, and it should quickly reimburse victims and seek taxpayer reimbursement from those responsible.
 

Only somewhat facetiousy, I would also recommend that:

  1. Economics and statistics professors use Poisson distributions with big tails instead of normal distributions. The unexpected happens far more often than we anticipate. Never assume you've got everything figured out.

  2. Lawyers who will get elected to Congress be trained on uncertainty and on the costs of delay. Just because the Minerals Management Service puts out regs on deepwater drilling safety, lowering the odds of an accident, but it doesn't lower them to zero. Build in a response mechanism to update best practices. The former head of the Minerals Management Service made a number of recommendations this morning, and one of them was to streamline safety regulations that can take years to implement under present law. Just because the SEC and the exchanges have lots of rules to insure orderly trading, we've seen they can be defeated and how helpless humans were to react.

  3. We avoid the Pearl Harbor effect, where multiple vague warnings and too often putting our forces on high alert resulted in poor reaction to the actual attack.

 



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