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a fickle finger of fate or the dirty digit of destiny?

May 27, 2010

Today’s lengthy story in the Wall Street Journal about BP’s missteps leading to the blowout in the Gulf and subsequent chain of disasters now consuming both the ecology and the news serves as a reminder of how fragile markets can be and why regulation is indispensable to our safety.  Despite the best intentions in the world, things go wrong.  We are all subject to exactly the same kinds of pressures BP faced–time constraints, escalating costs, mistakes in judgment, and the uncertainty of the unknown.  As one of the people I admired most in business, former Wachovia CEO John Medlin, once put it to me, you never see the lightning that strikes you.  So you can never entirely predict what can go wrong.

Without some kind of third party arbiter or enforcer, competitive pressures inevitably lead to a race to the bottom.  The time delays and expense of extra precautions, longer testing, better backup plans and crisis scenario planning place pressure on management.  Managers almost inevitably begin to skimp on safeguards and, without baseline rules and supervision, this leads to excessive risk taking.  The problem is not unique to BP; on the contrary, we have seen the terrible results of such unrestrained competition in many areas.  Mining and financial are the most obvious recent examples.  The short-termism of the market is inadequate by itself to ensure that discipline and precaution is spread adequately throughout the industry.

So regulation is one of the ways in which a “neutral” framework can be imposed.  In the case of oil drilling, the Minerals Management Service (MMS) was meant to be that arbiter but, as we have seen from the recent report of the inspector general for the Department of the Interior, that agency appears to have failed miserably in its job.  To be fair, however, BP even deviated from the directions of the MMS.

Bad things happen.  Sometimes this is used as an excuse.  Many defenders of practices on Wall Street tried to hide behind the so-called Black Swan, arguing that the financial disaster was simply unforeseeable.  Not only is this factually untrue–there were plenty of warnings in the run up to the crisis that were bluntly ignored–but it is also precisely the reason for precautions driven by interests greater than those of corporate executives.

There has been much finger pointing over the drama in the Gulf.  Of course there seem to have been numerous entities at fault and BP is probably not alone in holding the blame.  Holding the responsible parties accountable is critically important as a means of preventing or reducing the likelihood of future disasters.  But the blame game is usually unproductive for developing the right response and a model of safety for the future.  So much sober assessment and careful policy development will need to take place.  But to assume that a safe result can be achieved without a strong regulatory framework is unrealistic.

Believe it or not and despite everything that has happened, there are still some leading bankers who try to argue that government should get out of the business of financial regulation.  Leaving aside arguments about the right level of regulation and whether it is properly designed for effectiveness, public safety alone demands much more sophisticated, strong and thoughtful regulation than we have in many areas right now.

If we do not take the development of such regulation seriously, the fickle finger of fate will surely become a dirty digit of destiny.

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