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Of meltdowns and fallouts: What does the financial and the nuclear crises have in


By Georg Zachmann

The metaphors used for the financial crisis have reappeared in the news. Earthquake, tsunami,
meltdown, black swan and fallout have been both used to describe the (possible) events in the
financial markets in 2009 and in Fokushima recently. It might be the search of journalists for
powerful visual language. But maybe there are some revealing structural similarities. I would argue
that apart from being perceived as catastrophic both events have at least four similarities: (1) As
indicated by the “black swan” metaphor they are in part due to difficulty to correctly assess risks in
complex systems. (2) The “fallout” in both cases is potentially cross-border in nature. (3) The cost
incurred by the imprudent companies will be partially socialised. (4) Both events feature an
inability of regulators to forecast and prevent the crisis.

(1) There is one reading of the nuclear accident that highlights that a 9.0-magnitude earthquake is
an extremely exceptional event. As such events occur only rarely their probability cannot be very
well assessed with models based on limited historic data. Events with very low probability but high
impact have also been at the heart of the financial crisis. One reason for the financial crisis has
been the appetite of financial institutions for selecting (and in some cases also constructing)
products that have above-average returns in normal times but excessive losses in exceptional
cases. As we have now seen, old nuclear power plants in seismic zones have a similar payoff
structure. Another similarity is that, both, the financial and the nuclear risk models seem to not
have correctly appreciated the correlations between different risks. While financial institutions
tried to mitigate risks by bundling subprime mortgages, TEPCO’s cooling system was able to either
cope with a blackout and an earthquake or with a tsunami. But in both cases the failure-
probabilities were correlated and their joint occurrence led into catastrophe.

(2) Both, nuclear and financial meltdowns tend to have a fallout. In the Japanese case, only the
wind and the lack of a land-border prevented a major effect on neighbouring countries. In
continental Europe, many reactors are within a 100-mile range of another country’s territory. So a
nuclear accident in Europe would likely have a cross-border nature. But, like financial regulation,
nuclear regulation even in the EU with its Euratom treaty is still essentially national. And with the
large heterogeneity of the importance of nuclear power for European economies consensus on
regulatory harmonisation is hard to reach. While for France the economics of its power plant fleet
will remain essential as it will continue to produce the largest fraction of its electricity from nuclear,
Italy might have a much higher appetite for risk mitigation as it is not producing electricity from
nuclear power but is surrounded (within about one-hundred miles) by one Slovene, one Swiss and
six French nuclear power plants. This reluctance of the French government to include its nuclear
into a European regulation could be compared to the British efforts to prevent major European
harmonization of financial market rules because of its important financial service sector.

(3) Another similarity between both events is that the false risk assessment was largely due to the
asymmetric distribution of social benefit and individual cost of more effective risk mitigation.

© Bruegel 2011 1

Lehman and TEPCO were able to increase their profits as long as the risk they voluntarily or
thoughtlessly were willing to accept did not materialize. And their management certainly benefited
as long as everything went well. In the instant of crisis, however, the cost of the meltdown exceeded
the equity of the companies and had thus to be socialized. The arising question is whether there is
a structural failure in coping with complex private activities that have a risk of leading to large
societal damage. The simple answer is yes. In fact this is well understood and the reason why we
have regulators for most such systems.

(4) But, in both cases the corresponding regulators were not able to prevent the risk. The SEC did
not require more capital and halted risky practices at the big investment banks. And the Japanese
nuclear regulator did not enforced stricter security rules. In fact, regulators systematically fail to
prevent some of the events. There are several reasons for this regulatory failure. The inability to
acquire and process all relevant data, the political difficulty to enforce strict judgements and the
aforementioned difficulty to model tail risks are some of them.
Consequently, relying on low failure probabilities, national policies, the caution of private actors
and the monitoring by regulators seem to be insufficient to prevent catastrophe. So what should be

As in finance, insuring the risk and making the originator of the risk pay seems to be the most
sensible approach. If each power plant had to obligatory insure the risk it levies on the society
(within and outside its country of residence) it would face true economic cost of its activities. In
this ideal world, the individual plants insurance sum would be linked to certain influenceable and
non-influenceable impact factors such as location in a densely populated area and the risk-
adversity of the local population. Furthermore, the risk assessment should be linked to individual
plants risk factors such as location in a seismic zone, secondary-containment, redundancies etc.
Consequently, plants in densely populated areas with lower security standards would face higher
insurance cost. This could lead to a self-selected phase-out of the most risky plants.
The implementation of such a scheme is highly unlikely. First of all, it is virtually impossible to
correctly asses the risk profile of individual plant. And second, such a scheme would levy large cost
on only a few companies in a few countries. Their governments will fight hard to protect these
companies from being required to pay for the risks they impose on supranational societies. This
likely outcome parallels with the initiative for a European or global banking fund that should have
collected money to insure against the next crisis.

Nevertheless, in both cases the perfect insurance case could serve as a valid benchmark for any
policy implemented. Recommendations could thus be: (1) nuclear power plants should not be
phased-out according to age but to their risk profile (however schematic it is calculated). And (2)
cross-national insurance for nuclear accidents should be mandatory, e.g. under such a scheme the
Soviet Union in 1986 would have been required to pay for the costs the Chernobyl accident incurred
on European farmers and health system. Implementing these improvements will be difficult
enough, but as for the financial sector, crisis is the mother of reform.

© Bruegel 2011 2