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Systematic Risk, Bailouts and a New Energy Policy

Bailouts and the New Math

by ALAN FARAGO

The US Treasury is drawing the line on taxpayer bailouts, depending if a particular supplicant is part of the economic web that represents "systemic risk".

So, Citigroup is "too big to fail" today. Who can forget only a few years ago the experts judged gigantism to "disperse risk", or, that the experts now evaluating what represents systemic risk also judged the late, great asset bubbles to be acceptable. A decade ago I worked at a division of Citigroup; it was the failure of a senior manager to adequately explain the risks inherent in mortgage backed securities that triggered my personal systemic risk about the retail side of wealth management.

I was curious about securitized debt tied to housing because the suburban landscape of Florida didn’t add up. Environmentalists have always groused about "hidden subsidies" of sprawl; the inadequate infrastructure, badly planned schools and wetlands protection. What environmentalists failed to do was extend those overt hidden subsidies to the covert ones, concealed in tranches of mortgage backed securities and insurance derivatives tied to them.

To give credit where credit is due, environmentalists can’t be necessarily faulted for failing to pick up the trail of crumbs leading from devastated ecosystems to production home builders to local and state legislatures and Congress, to the White House and Wall Street. For the most part, environmentalists have been running from one leak in the dike to another, throwing up sandbags against the force of wealth creation based on securitization.

It is now clear that the entire formula for economic growth based on the housing asset bubble depended on mispricing risk. The curtain has been pulled back from trillions earned by Wall Street and its supply chain. Our economic and environmental crises are identical twins.

The same mispricing of risk is at work in a report headed to the Florida Public Service Commission, to Florida’s Governor Charlie Crist and the Legislature on the cost of energy alternatives ("Solar power costlier for Florida than nuclear power, report finds", The Miami Herald, Nov. 26, 2008).

A representative of the environment– Eric Draper, deputy director of Florida Audubon, is quoted by The Miami Herald saying he "wishes he had more time to read the document." His comment suggests that complexity needs more time to unwind. The report’s conclusion: that solar is considerably more costly than new nuclear power and natural gas.

I haven’t read the report; but the notion of "complexity" defying understanding has a very familiar ring.

Figuring out the relative cost of renewables is largely a matter of assessing risk; the order of calculations at the heart of what dragged the world economy into a chasm. What financial managers did– from former Fed Chief Alan Greenspan to former Treasury Secretary Robert Rubin– was to wrap themselves and everyone around them in an invisible cloak of complexity. That is how my branch manager, eight years ago, rebuffed questions about mortgage backed securities– suggesting, ‘Don’t worry. We know how to calculate risk.’

Let’s cut to the chase: there are only two relevant questions about pricing alternative energy; first, what is the cost of not converting from fossil fuels as soon as possible, and second, what is the cost of disposing radioactive fuels from nuclear power? The answer in the first case is unlimited risk. In the second case is too expensive to calculate.

The new arithmetic of bailouts, now said to total more than $7 trillion, attempts to zero out the risk to our economy from miscalculations by Wall Street and its supply chain. When it comes to assessing future risk in energy policies, no one should embrace bad choices because the arithmetic is too hard to understand. Been there, done that.

ALAN FARAGO, who writes on the environment and politics from Coral Gables, Florida, and can be reached at alanfarago@yahoo.com