It scares me when I realize how many people consider Thomas Friedman to be an important public intellectual. The New York Times columnist seems like an admirably curious but not very deeply grounded thinker at his best moments. At his worst he compounds confusion in the very areas he intends to clarify. The frightening part is that he has a highly visible and influential platform from which his opinions get taken far too seriously by far too many people.
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And, of course, being a man supremely confident in his powers of perception and proud of his keen understanding of the progress of mankind, he dives into the most pressing matters of the day with extra enthusiasm. Sadly,
this is one of those times...
I don’t expect much from the G-20 meeting this week, but if I had my wish, the leaders of the world’s 20 top economies would commit themselves to a new standard of accounting — call it “Market to Mother Nature” accounting. Why? Because it’s now obvious that the reason we’re experiencing a simultaneous meltdown in the financial system and the climate system is because we have been mispricing risk in both arenas — producing a huge excess of both toxic assets and toxic air that now threatens the stability of the whole planet.
If it's so obvious, could he please shut up about it and go away? Of course not. He's Thomas Friedman. We
need his advice, he thinks, whether we know it or not.
We're going to come back to Friedman's notion about mispricing risk as the key link between the financial meltdown and the climate in a moment. Let's let him explain himself a bit first. After all, anything that Friedman considers "obvious" must always be explained in great detail.
Just as A.I.G. sold insurance derivatives at prices that did not reflect the real costs and the real risks of massive defaults (for which we the taxpayers ended up paying the difference), oil companies, coal companies and electric utilities today are selling energy products at prices that do not reflect the real costs to the environment and real risks of disruptive climate change (so future taxpayers will end up paying the difference).
Whenever products are mispriced and do not reflect the real costs and risks associated with their usage, people go to excess. And that is exactly what happened in the financial marketplace and in the energy/environmental marketplace during the credit bubble.
If you think that sounds clever, you might just qualify as a New York Times columnist, but please try to avoid any positions of real responsibility because you're kind of an idiot.
The example of AIG selling insurance derivatives and comparing it to the sale of oil and coal makes little sense. In the first case, AIG was selling a product to customers who would be
personally and immediately impacted by any defaults. That puts "risk" into an entirely different context than the risk an oil company contributing in a vague and general manner to "climate change."
That is NOT the biggest problem with Friedman's analysis, but it certainly needs to be pointed out. It's an error he continually stumbles around throughout this column.
Our biggest financial-services companies, some of which came to be seen as too big to fail, engaged in complex financial trading schemes that did not adequately price in the costs and risks of a market reversal. ...
And our biggest energy companies, utilities and auto companies became dependent on cheap hydrocarbons that spin off climate-changing greenhouse gases, and we clearly have not forced them, through a carbon tax, to price in the true risks and costs to society from these climate-changing fuels.
My bolding above, because Friedman sure as shinola didn't seem to find it important. But think about it in your own terms. If you bought a security from AIG which might default, you would be personally risking any money you put into that investment, and also risking anything dependent on your expected return on investment. If you bought a gallon of gas for your car, spinning off "climate-changing greenhouse gases," Friedman is contending you have some kind of measurable and parallel risk involved. But you don't. Instead "society" bears the risk in some fuzzy arbitrary sense, which may or may not prove to be quantifiable in real terms.
Ah, but Friedman isn't completely an idiot. He's the sophomoric kind of idiot with just enough knowledge to be dangerous. He thinks this through and believes he's found a way to tie these different things together anyway...
“When the balance sheet of a company does not capture the true costs and risks of its business activities,” and when that company is too big to fail, “you end up with them privatizing their gains and socializing their losses,” Nandan Nilekani, the co-chairman of the Indian technology company Infosys, remarked to me. That is, everyone gets to rack up their private profits today and pay them out in current bonuses and dividends. But any catastrophic losses — if the company is too big to fail — “get socialized and paid off by taxpayers.”
So you see? In Friedman's world those investors of AIG products were socializing their risks
just like careless purchasers of gasoline. Neither one expected to
personally be affected by the negative risks involved in their transactions. So neither one worried about it.
Which only makes sense if you are, like Thomas Friedman, working backward from a set of facts and trying to force them together. It wasn't really like that at all. No one was ignoring the risks to their AIG investments because they figured the government would just bail out AIG if the economy crashed. The relevant risk was not "the economy might crash." Read any number of after-the-fact analyses and you find that the people involved had
no clue something so devastating was imminent. Lone voices in the wilderness warning of this possibility, like Warren Buffet, were basically ignored. No, the relevant risks were calculated investment by investment, with higher risks correlating to higher potential returns. People purchasing "energy-products" have no similar risk / reward calculation involved in their transaction in any meaningful way. This isn't a minor distinction it's a fundamental difference.
Watch the errant conclusions this kind of sloppy thinking can lead one into:
This is why we need new banking regulation that reins in the leverage and speculative trading that big banks and insurance companies can undertake so they never again become simultaneously too reckless to regulate but too big fail and taxpayers are forced to pay off the toxic assets they accumulate. And this is also why we need a tax on carbon — so we and our power utilities don’t become permanently addicted to cheap coal that makes for lower electricity prices today but spits out toxic greenhouse gases that have to be paid for by future generations tomorrow.
Where to begin?
We need regulation - though how this pertains to the risk born by the purchasers of investment offerings isn't mentioned. Why not? Because it makes no sense. The cost of investments
already reflects risks. The problem wasn't that this element was missing from "regulations," the problem was there were
major errors made in the way risks were being calculated by both buyers and sellers.
Friedman is conflating the whole "too big to fail" concept into this because he needs it for his argument to make any sense. But that was never involved in what caused the financial world's problem. If you will recall, Lehman Brothers kicked this whole bailout craze off by being... too big to fail? No. By
failing.
But Friedman needs you to ignore this, conflating what originally caused the problem with the fiasco of the bailout solution, so that he can persuade you that this provides a valuable lesson we must follow to institute a carbon tax...
That’s what “Market to Mother Nature” accounting is all about. It begins with the premise that the distinction between the G-20 and the Copenhagen climate change negotiations is totally artificial. They are just flip sides of the same global problem — how we as a world keep raising standards of living for more and more people in ways that will not, as a byproduct, have both the Market and Mother Nature producing huge amounts of toxic assets.
And here we see the danger of Friedman's half-informed musings in their full glory. He's squished together an apple and an orange, telling us how this makes them both better. In his mind he's created the "orple," which is an amazing improvement over the apples and oranges that came before. But if you stop buying into his hokey hucksterism ("Market to Mother Nature" - note the Important Capital Letters) you realize all he's left with is a smashed up apple and a smashed up orange which is really not an improvement at all.
Is there an actual parallel between these two diverse things - the financial meltdown on the one hand and climate change negotiations on the other? I think there is. And it leads me to conclude that Friedman, far from learning an important lesson from the financial collapse to save us from making a similar mistake regarding climate change, has concocted a solution that is actually a repeat of
exactly the same error.
You see in the financial world the problem, as Friedman correctly asserts, stemmed from mishandling risk. But
why and
how was the risk mishandled? Isn't that an important aspect to study before we try to draw lessons about it? Of course it is. And the answer was that the pertinent risks became increasingly reliant upon complex quantitative formulas built into computer models. The presumption wasn't that their risk was minimized by the certainty of government bailouts. The presumption was that they had figured out how to calculate their risk in exciting new ways which allowed them to discard traditional prudence and safeguards.
How certain were they that they knew all about the risks involved in their investments? Enough to base their entire companies' financial solvency on the presumption their risk calculations weren't wrong. After all how could they be wrong? It wasn't just one company's calculations - it was all of them. It wasn't just one computer model - the same figures came from lots of companies' computer models.
Of course that little hedge doesn't buy you much safety when all the risk calculations in all the software models share the same flawed assumptions. That's a lesson that holds true whether the flawed assumption is about the applicability of the
Gaussian copula function to financial risks, or
presuming a positive feedback where a negative feedback is likely in the climate. If all the models include the same error, multiplying their number won't reduce your vulnerability to that error.
How does such a thing apply here? Well Friedman is asserting that the world of energy transactions is understating risk just like the financial world was understating risk. He calls for addressing this by increasing the assumption of risk across the board in both worlds. Assuming you agreed with him you'd need to have some device for pricing this risk accurately at the individual transaction level. Friedman suggests a carbon tax would do this, but how would this be structured? It would have to be structured by presuming you can model the impact - the risk - of every carbon emmision, abstracting out other pertinent factors.
Does this sound familiar? It should. That is exactly the pattern that took hold in the financial world leading to the eventual collapse.
Remember David Li? Li was the quantitvative analyst who's risk modeling provided the means for the financial world to price complicated things by
abstracting the complexities:
Li wrote a model that used price rather than real-world default data as a shortcut (making an implicit assumption that financial markets in general, and CDS markets in particular, can price default risk correctly).
It was a brilliant simplification of an intractable problem. And Li didn't just radically dumb down the difficulty of working out correlations; he decided not to even bother trying to map and calculate all the nearly infinite relationships between the various loans that made up a pool. What happens when the number of pool members increases or when you mix negative correlations with positive ones? Never mind all that, he said. The only thing that matters is the final correlation number—one clean, simple, all-sufficient figure that sums up everything.
Getting back to Friedman, what is he suggesting if not applying this same pattern to the energy world? We're going to rely on models which tell us the carbon "footprint" of every single carbon emission on earth, in order to build the correct amount of "risk" into every energy transaction.
But, as I noted above, energy transactions aren't at all like investment decisions. The reason pricing the risk wrong in the financial world lead to an implosion was because some investments were presumed safer than others in a very concrete sense. The money invested in them was supposed to be safe - meaning the expected return on investment was supposed to be a sure thing. It was not meant to be safe in the sense the economy as a whole was not being put at risk. But that IS the kind of risk that Friedman's favored carbon tax is intended to capture. Which would lead to an entirely different kind of negative fallout if, god forbid, Thomas Friedman is wrong in his assumptions.
If you price the risk wrong in an investment, you risk losing the money you put into the investment. If you price the risk wrong in a carbon tax you destroy wealth and distort the market - which isn't all that different than what happens if you price the risk
correctly in a carbon tax. In the investment case, getting it right has a tangible benefit to lenders, borrowers, and only by the accumulation of sufficient numbers of such transactions to the financial world as a whole. In the case of a carbon tax, getting the risk
right is almost as destructive as getting it
wrong. The only difference is that if you've modeled the "carbon risk" correctly people living in some distant future time would be more likely to live in a cooler world than otherwise... presuming nothing significant happens in the next century for which the climate models have failed to account.
Perhaps it's time to turn to solutions in both worlds that are based more on hard evidence and less on trust in complex models barely understood by those making the key decisions. Perhaps that's the lesson Friedman should be trying to invent his new slogan around.
almost all of which have aged well. They can be arranged to suit a ton of different styles, but many lend themselves to being sung simply and sincerely. I also like that we're trying this particular theme with this particular set of Idolateers, because it will challenge every one of them in different ways. No one has the excuse of being a theme casualty this week. Anyone should be able to make this theme work for them. 
And I get another one of these: 
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