Epidemiologists, Hyman Minsky, and Forest Fires in Yellowstone

Why do crises happen, and how can we stop them? This is the question asked in many a field, from economics, to epidemiology, to research on forest fires. The problem is, as Minsky has explained, epidemiologists fear, and forest fires in Yellowstone Park have illustrated: the safer we make things, the worse potential they have for damage.

The best way to illustrate this is with a very visual (and uncontroversial) example: forest fires in Yellowstone. In the early part of the 20th century, officials in national parks began to suppress any and all forest fires that developed. This seemed to make sense, since forest fires could be very destructive to the forest and dangerous for people visiting it or living nearby, as well as for some endangered species living in the park. For years, every small fire was extinguished. The problem, we now know, is that this led to a buildup of dry, dead wood in the forest -- an enormous pile of fuel waiting to be ignited. The fires soon became harder and harder to control until a fire in 1988 destroyed 36% of the park's forested land. With that much fuel, it was just a matter of time before a drought (like the one in 1988) and other environmental conditions set the stage for a nearly unstoppable fire. Eradicating small fires over years made a really big one not only possible, but essentially inevitable.

Epidemiologists have the same fears. They know that the first time a disease strikes a "virgin population" (i.e. one that has never been exposed to the disease before), the effects are devastating. This effect contributed in no small part to Europeans' success in conquering the Americas: diseases like smallpox, brought by Europeans who were resistant to it, killed and weakened vast proportions of the native populations there.

Throughout human history, infectious diseases have been among the leading causes of death. Cities, in fact, were unsustainable because so many people died of diseases there; they required a steady stream of immigrants from the countryside to persist. By the middle of the 20th century, scientists in America and Europe began to declare that infectious diseases would soon be a thing of the past. They were wrong. Just as humans can build up a resistance to disease (actually largely via natural selection: those who have no resistance die), diseases can adapt to various treatments such as antibiotics, insecticides (for Malaria), etc. Last year, for the first time, a larger proportion of the world's population lived in cities than in rural areas. As mentioned above, cities are a great place for pathogens to live. On top of this, the lack of infectious diseases over the past 60 years means that our bodies may be "out of shape" when it comes to combating disease. The question, then, is if we will be able to stay ahead of diseases with vaccines and other measures. We must constantly adapt and must not allow a virgin, non-resistant population to build up.

This brings us to Minsky. He posited that free markets would always be prone to financial crises because long periods of stability would lead investors to take on higher risks (as their memories of past crises fade or as new generations with no memories come onto the scene). Eventually, debts would pile up to an unsustainable level, requiring only a trigger to set off something akin to a financial forest fire. He believed government regulation was the key.

I will take this one step further, combining with theories of evolution and epidemiology, and say that regulation will probably be unsuccessful in the end as well. For example, one reason the recent crisis has been so bad is that central banks have done such a good job at smoothing the business cycle. Securitization seemed to be doing a good job at spreading, assessing, and pricing risk, and government guarantees, whether explicit (FDIC) or implicit (Fannie Mae and Freddie Mac) seemed to take care of the rest. This lowered people's perception of risk and raised their appetites for it. It can therefore be argued that by hauling out the fire hose and stopping all the previous fires (like the dot-com crash of 2000-2001), the Federal Reserve allowed a pile of "dead wood" to accumulate that needed only a trigger (declining house prices coupled with rising commodity prices) to ignite it. VoilĂ ! Financial meltdown!

But don't stop here, these lessons can be applied to many other areas as well. This is just a hypothesis, but I bet Americans do more foolhardy things abroad than some other people because they are so used to everything being safe back home (e.g. "do not place house pets in your microwave"). The drive, often via lawsuits, to make everything safe in America could very well lead Americans to walk brain dead into dangers they no longer see. Here in Austria, I have another example. Austrians are so used to waiting for the light to turn green before walking across the street, and to cars stopping when the light is red (something I also expect in America), that they also no longer bother to look before crossing the street as long as the light is green. The typical response is "well, they have to stop. If they don't they'll go to prison." My response? A nice thought for you in the afterlife, I imagine.

The challenge now seems to be to control risks that are harder for individuals to see coming, while returning personal responsibility to those slammed by risks they really ought to have seen coming. What does this mean for the Viennese? Nothing, really, I'm certainly not advocating letting people who drive through red lights and kill people off easy. What does it mean for Americans? If you injure yourself by sitting on your folding chair after opening it incorrectly, it's your problem. What does this mean for the financial system? Look to Yellowstone. We need more small forest fires (recessions) and fewer explicit and implicit guarantees that give false security. Where guarantees are given, conservatism (as in low risk and low returns) needs to be enforced.

I'm sure there are more lessons. If you think of some, please comment.

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