MELBOURNE, March 4 (Reuters Breakingviews) – What does an Australian politician have in common with two former finance chiefs at Goldman Sachs (GS.N)? All three are guilty of using hyperbole to describe extreme events in ways that mischaracterise risk.
While presiding over the investment bank’s books, David Viniar and Harvey Schwartz both ascribed unlikely, if not impossible, probabilities to explain choppy markets. Dominic Perrottet, the premier of New South Wales, home to the country’s biggest city, Sydney, this week described floods that have devastated large swathes of his state and neighbouring Queensland as a “one-in-a-1,000-year event”.
Viniar’s flub came in 2007 as the financial crisis gathered steam. He pegged a particularly volatile trading period as “25 standard deviation events, several days in a row”. An academic paper put the lie to that, explaining how a comparatively low seven standard deviation event ought only to occur every 3.1 billion years. Later, Schwartz channelled his predecessor by referring to foreign-exchange ructions as “something like a 20-plus standard deviation move”.
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Elected officials and financiers alike are understandably on the lookout for simpler explanations of complex developments. The inaccuracies, however, expose inadequate understanding of what’s at stake. The measurement systems Wall Street relies upon, for example, are only as good as the assumptions used: Schwartz, after all, appeared to restrict his assessment to a certain time period. There are similar issues with the industry’s value-at-risk metrics, which only cover one-, three- or five-year periods.
It’s a comparable story with determining the frequency of severe climate events. The underlying data is actually trying to show the probability of them occurring in any given 12-month period. And it’s just a guide, really.
The trouble is that such language creates a false sense of security, much like the terms drought and natural disaster. They imply, respectively, short-term and unavoidable problems. Fold in poor estimates and the dangers can be incorrectly expressed and obscure the necessary response.
Australia, for example, spends just 3% of its disaster funds on adaptation and mitigation, per consultancy Risk Frontiers. And Deloitte reckons that climate change is expected to increase floods and bushfires Down Under by up to 50% by 2060. Left unaddressed, those two numbers combined will lead to a statistically disastrous outcome.
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CONTEXT NEWS
– New South Wales Premier Dominic Perrottet on March 1 described the record floods that have killed at least 12 people in his state and neighbouring Queensland as a “one-in-a-1,000-year event”. Hundreds of thousands of residents have either been evacuated or told to prepare to leave.
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Editing by Jeffrey Goldfarb and Katrina Hamlin
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