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Consequential & Catastrophic Risks

Consequential & Catastrophic Risks

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Published by Lyle Brecht
Discussion of public (government) and private (business) sector's roles in managing consequential and catastrophic systemic risks.
Discussion of public (government) and private (business) sector's roles in managing consequential and catastrophic systemic risks.

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Published by: Lyle Brecht on Nov 05, 2009
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04/02/2013

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The unusual and the unknown make us either overconfident or overly fearful.
1
A wise person will not spend time installing a burglar alarm when the house is on fire.
2
You know that the best you can expect is to avoid the worst.
3
Practical men, who believe themselves to be quite exempt from any intellectual influences,are usually slaves of some defunct economist.
4
CONSEQUENTIAL & CATASTROPHIC RISK
: For a world that will spend $1,500 billion (U.S.) this year for
National Defense
and over the past 64 years has spent almost$60,000 billion (in current dollars) for this purpose, today we may be faced with more
systemic consequential and catastrophic risks
than in any previous historical periods.One factor is the overdetermining belief that
military defense
primarily renders a na-tion safer (look at the nation’s spending budget to see relative priorities for what isimportant). However, maybe the two primary reasons that the world has gotten risk-ier is that: (a) technology is enabling low-cost, distributed activities heretofore previ-ously unimagined; and (b) adequate capital has not routinely been allocated to miti-gate these sometimes new or newly understood consequential and catastrophic risks.Instead, traditional and conventional military-centric risks have consumed much of the world’s capital used forrisk mitigation. Adding to the concern of adequate capi-tal allocation to mitigate new risks is a
corporatist
mindset that portrays risk man-agement as government interference in free markets and eschews regulatory reformas anathema to capitalism.
5
TYPES OF CONSEQUENTIAL AND CATASTROPHIC RISK
:
Consequential risk
 describes risks that are
economically
 
expensive
should they occur. Locally, this mightentail a one-time, sudden, unbudgeted expense of ten’s of billions of dollars. Nation-ally or globally, this might entail a sudden unbudgeted expense of trillions of dollarsin losses.
Catastrophic risk
typically also entails loss of bio-physical resources, often-times directly, human lives. Locally, this might mean the sudden death of 10,000 -100,000 humans; nationally, 100,000 to a few million humans; globally, a few millionto virtually the entirety of the six billion people presently living on the planet (i.e.
existential risks
that threaten humanity
in toto
). Catastrophic risks
always
are conse-quential. But not all consequential risks produce immediate, directly attributable sig-nificant numbers of deaths. Any deaths from consequential risk may be indirect andsecondary. In evaluating both consequential and catastrophic risk, an appropriatetimeframe must be chosen. For example, short-term loss of human life over a fewdays to a few weeks may be slight, but long-term loss of life over months or yearsmay become very large. Oftentimes, there is bias to consider risks that are
episodic
(anevent that just happens e.g. an earthquake or terrorist attack) and produce conse-quential results over a short time span (e.g. the event fits within the attention span of TV news shows) versus
structural
risks (e.g. nuclear deterrence and nuclear power
CONSEQUENTIAL & CATASTROPHIC RISK
Lyle Brecht
DRAFT 1.12
Sunday, November 15, 2009 CAPITAL MARKETS RESEARCH - Project Metanoia - Page 1 of 18
 
plants are structural risks in that they are inherently expensive when they fail. Two billion dollars in capital investment was turned into a useless rubble of steel and con-crete at Three Mile Island in less than 30 minutes). Other risks
evolve
sometimes pro-ceeding over relatively lengthy timeframes and result in very large economic costs(e.g the cost of global warming, if absolutely no mitigation occurs, and atmospheric
tipping points
are exceeded, could be as much as $200,000 billion, but not be fully feltfor a 100-years).Consequential and catastrophic risks can generally be classified into four distinctcategories that are independent of their potential severity (probability x harm):Known events that are certain to happen with some known or historically rea-sonable probability. They have happened before and most likely will happenagain at some discrete time in the future;Known events that are certain to happen (we know this from a history of theearth), but a probabilistic forecast of their eventuality in discrete time is uncalcu-lable at present. We just do not understand the risk well enough to even guess atits probability of occurrence, or even if we guess, we have little confidence in ourguess;Known events that may or may not happen sometime in the future, dependinglargely on the particular planning period of the analysis. Typically, we just do nothave enough historical data points to plot a frequency curve, or we do not un-derstand the mechanisms of the risk event well enough to know for certain thatthey will occur again in the future or with what frequency. What we do know isthat these risk events
have
happened in the past;Unknown or dimly understood events that will occur with some uncalculableprobability. These are often referred to as uncalculable,
rare
events. Becasue theyare rare, there is just not enough understanding of the event itself, nor its fre-quency to plot a probability curve. Sometimes these uncalculable, rare events arereferred to as
Black Swans
. What a risk manager must remember is that eventhough a specific rare event may not be knowable either as to probability orharm, the
class
of Black Swan risks is highly probable to occur in any one plan-ning period. That is, it is almost always prudent, from a risk management per-spective, to plan for a Black Swan and to manage systems for their resiliency toavoid cascading failure or collapse, should a Black Swan appear during the plan-ning period.Against these categories of consequential and catastrophic risks, there are generallythree types of human responses available:
CONSEQUENTIAL & CATASTROPHIC RISK
Lyle Brecht DRAFT 1.12 Sunday, November 15, 2009 CAPITAL MARKETS RESEARCH - Project Metanoia - Page 2 of 18
 
Allocating capital to mitigate this risk will likely either reduce the probabilitythat an event will occur or improve
resiliency
(ability to recover) and reduce harmshould the event occur;Allocating capital to mitigate this risk will either be to no avail or make the risk worse, either by increasing the probability of occurrence or the economic costshould an event occur;The risk is beyond human amelioration or mitigation at the present time. Thisdoes not mean that at some future date human ingenuity may mitigate this risk,only that at present humans are powerless to do anything about this risk In summary: consequential and catastrophic risks can either result in only economiclosses, or economic losses with loss of lives. Possible events can be known with cer-tainty, with some degree of certainty (probabilistic forecast), or with no certainty(probabilities of occurrence are uncalculable). For some risks, it is possible to mitigatethe risk event. For some risks, attempts to mitigate the risk may make things worse.For some risks, no human mitigation is possible at this time.From a capital allocation perspective, it is imprudent to invest in mitigating onlyknown, tractable events of a particular class (e.g. risk of war or terrorism vs. risk of global warming and cyberspace security). Risks that have uncalculable probabilitiesof occurrence should also receive appropriate mitigation capital, given the nature of rare events that, as a class, they
regularly
occur in any one planning period . It is alsoimprudent to invest primarily in
hardening
systems against an event occurring. In-vesting to improve system resilience, should an event occur, may also be a worth-while mitigation strategy.The table below categorizes consequential and catastrophic risks by their potentialscope: local, national, regional, global, and
existential
(risks that threaten life on theplanet). What is not illustrated in this table is that risks that begin at the local level,may produce cascading failures that grow to the national, regional, or even globallevel. Two example s of cascading failures might include localized drought that re-duces food production to an extent that national or regional consequential effectsoccur. Another risk event that may begin locally could include a nuclear exchange between India and Pakistan over Kashmir or between North and South Korea thatcould quickly cascade to national, regional, or even global risk events involving lossof a growing season due to particulate matter in the atmosphere, the triggering of anew climate change regime that produces severe regional or global drought, or otheras yet unforeseen cascading failures of existing present ecosystem services that un-derlie all the economic support systems for all the national economies of the world.
CONSEQUENTIAL & CATASTROPHIC RISK
Lyle Brecht DRAFT 1.12 Sunday, November 15, 2009 CAPITAL MARKETS RESEARCH - Project Metanoia - Page 3 of 18

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