NTSB for Financial Services

This is not a new idea – lots of people have called for financial regulators to set up a body for markets that resembles the NTSB.  It isn’t even all that brilliant – it’s more like the proverbial no-brainer.  Why don’t we have an NTSB for Financial Services?  Why don’t we treat market crashes the same way we treat airplane crashes?  The National Transportation Safety Board has made airline travel (and railway, ferry and other public transit)  extremely safe in a relatively short amount of time.  How did they accomplish this feat?  Simple – every time there is an accident, or a near accident, a team of investigators figures out what caused the accident/incident and then regulations are put in place to prevent that particular thing from ever happening again.  Airlines are required to adhere to the new rule.  Required – as in “you don’t fly if you don’t do this.”  The NTSB’s origins can be traced to the Air Commerce Act of 1926 in which Congress required the Department of Commerce to investigate the causes of airplane crashes.  At first the benefits were slow in coming.  But over time air travel has become much safer.  Sure, it takes time to investigate and it takes time to enact the appropriate new regulation, and the process is far from perfect.  But it works.  Today, I am completely comfortable getting on a commercial airliner (in the developed world) because of this.  It has reduced the accident rate to a negligible level.  And as long as this process continues, air travel will remain safe.

Let me suggest some good background reading: Prof. Andrew Lo’s testimony to the US Congress in 2008.  While the entire document is worth reading, the part where he describes a “Capital Markets Safety Board” (CMSB) starts on page 18.  He does a good job explaining how a CMSB might go about its business.  But setting this up would require quite a bit of political will, and once it’s established the challenges will have just begun.  I’ve heard it suggested that because economics and markets are so driven by human behavior that it’s impossible to definitively determine what causes market crashes.  While I agree that it’s very difficult to pinpoint the causes of market crashes, I will point to a surprising example from air travel to demonstrate that the human element doesn’t make forensics impossible.

The single worst air travel tragedy in history occurred on March 27, 1977 in the Canary Islands when a KLM 747, while attempting to take off, collided with a Pan Am 747 in heavy fog, resulting in 583 deaths.  NOVA has a terrific episode about the crash that’s worth watching, as is everything NOVA puts out.  I won’t go through all the details here (again, this is a fascinating show that I recommend you find the 50 minutes needed to watch), but will point out that the KLM pilot, Captain Jacob Veldhuyzen van Zantent, was one of the most highly decorated 747 pilots in the world.  He trained almost all of Holland’s 747 pilots and co-pilots.  He was the most senior safety officer at KLM.

March 27, 1977 Crash of two 747s in the Canary Islands

A number of seemingly small incidences – none of them individually material – added up to this crash.  Both planes were diverted to the Los Palmas Airport.  The KLM crew was nearing its legal work-day length limit and was in a hurry to get home.  The Pan Am flight missed its designated taxi-way and remained on the active runway, heading toward the next taxiway.  That day, planes were reverse-taxiing on the one runway and then taking off down the same runway.  The Pan Am cockpit and Air Traffic Control were speaking at the same time, preventing the KLM cockpit from hearing that the Pan Am plane was still on the runway.   Heavy fog rolled in limiting visibility to 300 meters.

The end result of what actually caused the crash was behavior.  Human behavior.  The KLM co-pilot, who was trained and approved by the pilot, corrected the pilot already once that day.  Just before the crash, the KLM flight started to take off when the co-pilot reminded the pilot that they had only been given clearance on a particular route once in the air, but that they still did not have clearance to take off.  A few minutes later, the pilot again started taking off and this time the co-pilot did not stop him, resulting in the crash.  Net net, the official report blames the KLM pilot for the crash and that the cause was the culture of reverence to authority figures in the cockpit.  The co-pilot it seems was aware that they should not have been taking off but he did not challenge his superior officer a second time.  He paid for that mistake with his life.  Since then, the NTSB has mandated that similar situations be simulated: a senior officer making a material mistake and the junior officer having to correct him.  The training involves both officers: the younger ones need to get over the fear of contradicting a superior and the senior officers need to learn to accept the correction.  At least for me, this example shows that behavioral aspects can be accounted for in such a setting, and regulators can come up with effective ways of limiting the risks of behavioral causes.

I do wonder though, if markets would accept the level of scrutiny and authority that would come with a CMSB.  If governments go down this route, then that Safety Board has to be granted real teeth, like the NTSB has.

One Response to NTSB for Financial Services

  1. Great article, Damian. I just saw this today.

    There’s a certain number, called the Value of Statistical Life (VSL) that is used to evaluate the cost/benefit of certain things, and that number is about $5.5mil for a human life (http://en.wikipedia.org/wiki/Value_of_life#Policy_applications_of_the_VSL)

    If the crash of 2008 caused the global economy to lose $30.1 trillion dollars (http://www.davemanuel.com/2009/01/02/global-stock-markets-lost-301-trillion-dollars-of-value-in-2008/), then by my rough calculations, that was the financial loss of the equivalent of over 5 million people.

    THAT would certainly be enough to cause the creation of a governmental agency to oversee security of these things.

    Of course, with the intelligence that the government has been showing, we’d probably all just be groped on our way to the ATM.

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