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BP Spill: Ripples

The role of risk in BP’s oil leak

Marketplace Staff Jun 3, 2010
BP Spill: Ripples

The role of risk in BP’s oil leak

Marketplace Staff Jun 3, 2010


Kai Ryssdal: New York Times economics columnist David Leohnardt has been writing about why the blowout on the Deepwater Horizon happened. Not really the mechanics of it all, but more the human nature of it.

David, hello again.

David Leohnardt: Thank you Kai. It’s good to be on.

Ryssdal: The drive for profits and how that affected some of BP’s actions, we have all read and heard much about in the past six weeks. You, though, this past weekend in the magazine, brought up another point. Something else that might have been a bit more human involved.

Leohnardt: That’s right. First of all, I agree that the drive for profits played a big role. And I think it interacted with this other more universally human issue, which is we’re not very good at estimating the odds of something that is unlikely, but that brings huge costs — like an oil rig essentially blowing up.

Ryssdal: Or like, gee, I don’t know, the entire U.S. housing industry going down the train, right?

Leohnardt: That’s right. So one of the justifications we heard for the housing bubble was that, “Well, no, we’re not in a huge bubble, because we’ve never been in one before.” Basically, what they said was house prices have never fallen nationally, you had people on Wall Street, as Michael Lewis has reported, building models that didn’t even allow for the possibility that house prices would fall. And so what they did a bad job of doing was saying, “OK, how should we deal with this thing that we think is unlikely, but that if it happens — based on the edifice that we have built — could cause terrible damage to the United States economy.” And because they had a hard time imagining it, they didn’t take the necessary precautions.

Ryssdal: Well, let me ask you this, though: That’s the underestimation of risk. What about the overestimation of something happening?

Leohnardt: That happens as well. When something is very easy to imagine, we often overestimate its odds of happening. One example of that is plane crashes. We think they’re much more common than they really are, we tend to react to them more than we react to car crashes, for example. When in fact, plane crashes are much less common than car crashes and kill many fewer people.

Ryssdal: Is there a market mechanism that can correct this bias that we have?

Leohnardt: Yes and no. To some extent, there’s nothing we can do to magically get rid of this bias. But that being said, you want to design policies that would push back against it. What’s tragic in this case is that we actually had a policy that aggravated. We have capped the amount of damages that oil companies would pay for a spill like this. And if anything, that encourages them to take more risk, to not worry about these odds.

Ryssdal: This is that $75 million cap that was put in place after the Exxon-Valdez, and your point is that the BP guys who were making the decisions said, “Yeah, we don’t have to worry so much, because all we’re going to have to pay is $75 million.”

Leohnardt: That certainly seems like a reasonable supposition to make. You have to think that encourages to take more risk to not worry about these odds.

Ryssdal: Mmmhmm. So, as we prepare for the inevitable slew of new rules and regulations that will follow this event, I guess it’s your position that we’re likely not to get it right. That we’re going to put something in place that down the road, we will say, “Oh man, we didn’t think this through.”

Leohnardt: That’s right. And we’re specifically not likely to get it right in the following way: We are likely to overreact to this specific disaster, the one we can now easily imagine. But we are certainly likely to take not enough steps to prevent other similar catastrophes.

Ryssdal: Or just to bring it back to business in the economy, a financial crisis that will happen not like the one that we just had.

Leohnardt: That’s right. The next one is not going to involve the housing market. Maybe it’s going to involve something else that’s even harder to imagine. We shouldn’t always be so comfortable that everything’s going to work out OK.

Ryssdal: David Leohnardt, the staff writer for the New York Times Magazine, also an economics columnist for the newspaper. David, thanks a bunch.

Leohnardt: Thanks Kai.

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