The paperback of Flirting With Disaster is out!

FWD-Black-cover

I’m pleased to announced the availability of Flirting with Disaster in paperback.  It has a spiffy black cover and is available from Amazon and Barnes & Noble. (B&N also has an e-book version that plays on Apple’s iPhone and Touch, PCs and Macs.)

Additionally, Truthout.org has published a new interview with me about the book and my latest research and papers. Of particular interest may be the Truthout article I recently published about a long-running medical cover-up at Columbia University Medical center. You can read about it here. There will be more from me on Truthout in the coming weeks.

m/

Subprime: Avalanche conditions are still in effect

Dorothea Lange's portrait of destitute California pea picker mother and children during the Great Depression.

The U.S. and the global economy, except for a few isolated places, is in a world of hurt, the worst since the Great Depression. The good news — and a really important part of the solution — is that officials around the world (now including the U.S. Congress, who have been until recently largely on the sidelines) are not in denial about the imminent threat. Their cooperation and decisive action is not all that’s needed, but it is nevertheless critical to success.

As you know from Flirting With Disaster, psychological denial is an all too common response to risk. As in this case, it often takes of form of refusing to accept the magnitude of the potential catastrophe, or ignoring the signals of danger, a justifiable criticism of various financial leaders such as Alan Greenspan, who were concerned, to be sure, just not concerned enough to change the status quo.

Denial is a far more commonplace and powerful a motivator than we typically acknowledge, since it affects our perceptions of our own weaknesses as well as our views about our contribution to things that go wrong. As a result, most of us find it easy to avoid responsibility by blaming others, and we find it very difficult to learn from our mistakes. There is a lot of finger pointing going on now, and we should expect that it will get more intense as time passes — it is a lot more satisfying to blame people than systems.

To break through such denial and precipitate decisive action, it usually takes a full blown catastrophe. We are truly fortunate that the economy is not in a far deeper crisis, as bad as things are at the moment.

Ben Bernanke, Chairman of the U.S. Federal Reserve

One reason we may have been saved from disaster is that many of the current financial policy-makers have been through the S&L debacle, 1987’s Black Monday, the 1990s Asian financial crisis, the 1998 Russian bond default, and the collapse of Long Term Capital Management. Ben Bernanke, chairman of the Federal Reserve and the brains behind the current corrective strategy, is an expert on the mistakes of the Great Depression and Japan’s 1990s property market collapse. Together, the U.S. financial leadership knows all too well how bad things will get if the current crisis is not stemmed, and they have not minced any words with the U.S. politicians about how serious the current situation really is.

The bad news, however, is that in spite of considerable wisdom and a clear bias for action, human beings are generally pretty terrible at understanding the nasty nature of complex, non-linear systems, like the behavior of the financial markets. I don’t want to turn this post into a technical treatise, since I discuss these topics in FWD and on my web site, but the tightly integrated, derivative-based, global financial system simply does not behave the way many policy-makers, financial gurus, and Wall Street titans often imagine. Deregulated derivatives and the frictionless globalization of financial markets, in particular, have created surprising instabilities and massive world-wide risk. It is entirely fair to say that we do not really understand extreme market behavior, periods characterized by a volatile mix of widespread fear, economic reality, and radical government intervention that unpredictably rewrites the rules of the game in mid-play.

The late Fischer Black, co-creator of the Black-Scholes-Merton options pricing model that arguably created the modern world of derivatives nearly forty years ago, worried greatly about the departure of financial models from reality. But Black was often a lone voice, and other financial gurus and their minions that populate today’s financial centers often behave as if they can price products accurately, mark them to market effectively, and accurately quantify the money at risk if events turn against them.

Fortunately, most of the time they get things right, but sometimes they are spectacularly and catastrophically wrong. In the current case, being wrong might mean precipitating a global economic disaster of previously unseen magnitude and duration. This is not hyperbole, it is simply a statement that no one really knows how close we are to the precipice, how deep is the abyss, and how long it might take to climb out if we slip. We are, as has now been publicly acknowledged, in uncharted territory. Fortunately, no one in a responsible position appears to think that this is a risk worth taking, and we must be very thankful for that.

Of course, courting danger and dangerous excesses are not unusual in the case of new technology (which is what derivatives are), as MIT professor Nancy Leveson makes clear in her insightful discussion of steam power during its early days. What is different in this case is the emergence of realistic systemic risk. Unlike an exploding steam engine on a new freighter, the likelihood that a failure in one part of the financial system could uncontrollably propagate to create a global catastrophe in the same way that a local rock slide can, under certain conditions, precipitate an avalanche. Although the world is actually no stranger to financial crises preceded by a run up of asset prices and mountains of debt, today’s risks appear to be a new development in the global financial system.

I should also remind you that the current crisis fits the characteristics of a “normal accident,” the term coined by Yale sociologist Charles Perrow, who cites high interdependence and the “tight coupling” of the system’s parts as the worrisome preconditions because they can lead to crises that are quickly “overtaken by events.” This is exactly the situation we have created in global finance, but the irony is that many features of this system, such as Value at Risk measures, mark-to-market rules, and credit default swaps, were created to reduce risk. As we have learned to our horror, however, these powerful tools are swords that cut both ways, and it is now clear that we are in the path of the back stroke.

One of the questions that many people are asking is “How come no one saw this coming?”

Brooksley Born, Chair of the CFTC, 1996-1999.

To give credit to the experts, some of the technical financial literature was far more honest about the current state of knowledge and risk than the marketing materials issued by the investment firms. In addition, Brooksley Born, head of the U.S. Commodity Futures Trading Commission (CFTC) issued a stern warning about derivatives in a 1997 speech to the New York State Bar Association. She presciently claimed that the proposed deregulatory legislation — eventually enshrined in the Commodity Futures Modernization Act of 2000 or CFMA — would allow trading “to operate in a lawless environment, completely free from government oversight or market regulation.”

Neither the 1998 collapse of Long Term Capital Management or that of Enron in 2001, both of which revealed large scale risks related to derivatives, did much more than generate heated arguments pro and con greater regulation. The CFMA was, in fact, the result of a considerable lobbying effort by the financial industry as well as a follow-on to the hundreds of millions spent in lobbying and campaign contributions that had resulted in the 1999 Gramm-Leach-Bliley Act that dismantled Glass-Steagall, the 1930s legislation that had separated banking from Wall Street from insurance.

After derivatives were, for all intents and purposes, completely deregulated by the CFMA, the Bank of International Settlements issued a worrying 2003 report that identified growing systemic risk as a result of derivative products, and by 2006 — even prior to falling house prices (see graph below) — it was clear to some that subprime mortgages represented a serious threat to the financial system as a whole. But greed and denial continued to dominate short term actions, and toxic mortgage-backed products continued to be flogged and no corrective actions were taken in spite of the worries. This is not that surprising since there was virtually no regulation, and the strong free market ideology of the Bush White House and Wall Street combined with considerable financial incentives to dampen any interest in revisiting the issue.

Beyond this, one more factor was the tremendously powerful psychological force. It goes by the curious name of “moral hazard.” Simply stated, moral hazard reflects the tendency of people to take less prudent care if they believe that they won’t have to bear the full consequences of their risk-taking. It shows up in subprime crisis in four diabolical ways.

The first bit of nastiness flows from “securitization,” the bundling of groups of mortgage loans (or other assets) that are then sold like traditional bonds. While securitization is not inherently bad — in fact it is an important financial tool to move risk from a party that has too much of a particular type to someone who would like to assume that risk in order to get its return. The problem in the subprime case arises from the erosion of standard financial prudence during the loan underwriting process. The psychology is simple: if the originating mortgage company does not have to take financial responsibility for repayment (they make their money “up front” from fees and then sell rather than hold the mortgages they originate), they do not have to be that concerned about the quality of the borrower.

In consequence, many unregulated mortgage companies made large numbers of imprudent, arguably irresponsible loans that had a far lower probability of being repaid — especially under untested adverse conditions — than the historical averages suggested. This imprudent underwriting is ultimately the root cause of the current crisis. It was also one of the few areas in which the Fed could have intervened within existing regulations.

While the bet (and the sales pitch) was that rising home prices would allow the risky subprime borrower’s mortgage to be restructured, thus avoiding default, it was clear to many that such refinancings (and rising housing prices) could not go on forever. While this was not a problem for many mortgage originators — i.e., those who never planned to hold the mortgages — it was a problem for the buyers of the securities which depended on those mortgages, although they did not realize it at the time because they were told by the credit rating agencies (CRAs) that the fancy bond-like securities being sold were “investment grade”.

The second part of the moral hazard problem, therefore, was the cooperation of Moody’s, Standard & Poors and Fitch, in particular, in the securitization of structured mortgage-backed products. For reasons that are still unclear, but have been linked by some observers to conflicts of interest between the CRAs’ commercial objectives and their role as independent risk assessors, these agencies were willing to rate subprime mortgage-based assets as investment grade, even though they were composed of risky subprime mortgages or other derivative products based on such mortgages.

This counter-intuitive vote of confidence was based upon the elaborate structure of the mortgage-backed products which, according to the rating agency’s mathematical models and the historical default rates they used, created the statistical likelihood of financial performance emulating that of many traditional corporate bonds. One can easily imagine that with the rating agency’s stamp of approval, institutional and well-healed private investors thought that they were making safe and prudent investments, especially since the same bond rating nomenclature was used to categorize these new structured products as had been used to rate traditional corporate bonds. (Note that both enhanced returns and common rating labels were exactly what the institutional investors wanted, since regular corporate bonds had very low yields during this period, and there was commercial pressure to improve performance.)

It might be reasonable to say, therefore, that if the credit rating agencies didn’t “rob the bank,” they certainly “drove the getaway car,” albeit in what appears to be a perfectly legal manner. They were often deeply involved in the structuring of the new products (from which they extracted a sizable portion of their total revenues), and it is clear that many institutional investors lacked either the expertise or the information to evaluate the risks of the new products on their own. To make matters worse, it appears that the CRAs did not aggressively seek detailed financial information from the issuers about mortgage borrowers or current home prices that might have provided better insight about the changing likelihood of default as conditions evolved. Furthermore, while the CRAs did provide an additional range of advisory services to institutional investors on the quality of the derivative-based assets they owned, they neither comprehensively re-rated them, nor fully assessed the magnitude of the potential losses as circumstances changed and rating methods improved.

Of course, there was still some residual risk, and it demanded capital reserves from the buyers. This brings us to credit default swaps (CDSs), the third moral hazard contributor. Basically, a CDS is a derivative, a contractual form of insurance protection that pays off if a loan, bond or complex securitized product loses money because of defaults. It is easy to see that owning such insurance would let you sleep more soundly if the securities you had bought ultimately rested on loans made to people with questionable credit histories and uncertain employment — i.e., the sub-prime borrower. (It’s worth noting that since the new securities paid such good rates of return, it appeared to remain a good deal even considering the additional cost of insurance.)

It is important to recognize that while the risks from mortgage defaults had to go somewhere (I like to think of this as the “conservation of risk,” not unlike the conservation of matter and energy), this fact did not bother most investors. They were, after all, holding an “investment grade” security and an insurance policy — “belts and braces,” as they say. However, beyond an obvious concern about their individual holdings, investors were largely unaware of — and perhaps unconcerned about — the collective risk that was building up as the total amount of risky mortgages, derivative products based upon them, and CDS-based insurance ballooned astronomically in the marketplace. This shared risk is an example of the “tragedy of the commons” in which rational individual action can lead to lower prosperity for all.

But let’s examine this from the investor’s point of view: In order to appreciate this larger risk, they would have had to believe that historical default rates were going to change, that the rating agencies didn’t know what they were doing (or were colluding with the issuers), and that the insurance they had purchased (often from very large, well known firms like AIG) would not pay off. For most investors, such circumstances were simply unthinkable, or at least of exceedingly low probability. They were, in fact, both irresponsible and in denial — but perhaps understandably so in light of the dramatic increase in complexity of these new products and the changing nature of the marketplace that derivatives had wrought.

The final element of the moral hazard problem was a belief that the U.S. government would not allow large financial institutions to collapse, even if they got into trouble by their own hand. This is often described as “too big or important to fail,” and there was no reason to doubt the existence of such a safety net since bailouts, guarantees, and private sector arm-twisting have always been part of the U.S. economy, including the rescue of the S&Ls during the 1980s, and loans to Mexico during the 1994-95 peso crisis, and the Fed-orchestrated liquidation of Long Term Capital Management in the wake of the Russian bond default in 1998, to name but a few.

Of course, there was little thought of bailouts during the expansion phase of the housing bubble. Nevertheless, a government cushion has doubtless been a factor preventing internal corrective action by the banks or their counterparties when the first serious signs of trouble started. Based upon recent actions, assumptions of a government rescue were a pretty safe bet.

When the wheels came off

Case-Schiller Home Price Index 1987-2008

The housing bubble that had propelled house prices upward by over 10 percent in 2002 and by over 25 percent per year from 2004 to the middle of 2005 finally burst in August 2005. With its collapse, home sales slumped, and, with lower demand, house prices started to fall in 2007 for the first time since 1991.

Not surprisingly, the subprime industry collapsed in the first part of 2007, marked by the bankruptcy of New Century Financial, the largest U.S. subprime lender. By August, the crisis is in full swing, and many financial institutions reluctantly revealed that they had subprime mortgage backed securities in their portfolios. The damage spread to the UK in September with a very public bank run on Northern Rock Bank followed by the British government’s takeover of the institution. The collapse was triggered by credit problems related to subprime.

In 2008, things have gotten much worse after a period of relative calm. In March, Bear Stearns — a major player in the subprime market — was acquired to avoid bankruptcy in a government guaranteed fire sale. In September, in rapid succession, the federal government took over Fannie Mae and Freddie Mac, massive players in the U.S. mortgage market; Merrill Lynch was sold to Bank of America; Lehman Brothers collapsed when unable to secure financing; and giant insurer and sub-prime CDS issuer AIG was effectively nationalized by way of an $85 billion dollar federal loan that effectively transferred 80 percent of the firm’s equity to the government.

What’s next, and what happens after that?

The capacity for denial is so great, self-interest so powerful, and the dominance of linear short-term thinking so pervasive that for quite a while many leaders believed that things could be fixed with the usual tinkering and modest funds. Such reasoning is often correct because the self-correcting behavior of financial markets are reinforced by many overlapping forces.

Sometimes, however, such complex systems become fundamentally altered by deliberate changes, or they are simply pushed into a new state in a transformation that physicists call a “phase change.” Mixing iron with the right other elements can dramatically transform it into stainless steel, and no one would think that water below 32 degrees F behaves the same way it does when it is warmer. In an analogous way, unregulated derivatives, the tightly bound global counterparty network, and mark-to-market rules have altered global finance at a fundamental level, not just superficially. While day-to-day business appears to be much the same as before, the system itself is very different than it was even a decade ago.

Despite the efficiencies and greater robustness celebrated by free market advocates, global finance is capable of catastrophically dangerous modes of behavior. Never before, for example, do we face trillions of dollars of financial products so complex that they cannot be easily valued, or have we seen a freezing up of credit on a global scale despite a world awash with cash, or the need to raise a total of nearly a trillion dollars to fund the U.S. bailout, yet have no idea whether it will be too much or not enough. Like global terrorism, this is a different class of problem than we have previously faced, even if many of its elements have been around for decades.

Going forward, therefore, we must tackle two quite different challenges, both enormously difficult. First, we will need to bail ourselves out of the mess we have made. This will take sound judgment, political cooperation, and an unprecedented amount of public money in combination with leadership capable of standing up to the vested interests that have already started to lobby to shift the cost of their mistakes to the taxpayers. Don’t think for a moment that finding a solution will be easy, that we can’t screw it up, or that our best efforts will necessarily work. There are simply no guarantees.

Particularly vexing is the valuation of the assets to be bought under the current bailout proposal. With the economy largely frozen and mortgage defaults rising, many of these assets are worth little (even assuming that they can be valued at all under these conditions), but if the bailout works, economic conditions will improve and foreclosures will fall, making the assets worth more. Such “widening spreads” between buyers and sellers is a generic characteristic of illiquid markets, but in the absence of trading there are no guidelines to establish rational prices.

Even more problematic is sharing the cost of past mistakes with the executives and shareholders of the companies participating in the bailout. Some critics have argued that equity in these firms should accompany any asset purchases. Further, that the responsible parties should not benefit in any way from the rescue. While this may be equitable, and despite considerable support, it may yet prove to be a hard sell that may dangerously delay implementation.

Second, we will have to redesign the regulatory system and market structure to deal with finance’s new reality, a reality that we have failed to recognize is as dangerous as it is a powerful engine for growth. The Black-Scholes-Merton formula has become for finance what E = mc2 was to physics: the gateway to the atom bomb as well as to nuclear power and a deeper understanding of the universe.

When we redesign banking and the markets and the rules they both live by, I hope we are sufficiently humbled by the fact that we very nearly blew ourselves up. Next time, we may not be as lucky — although this seems to be a lesson humankind never seems to learn.

m/

Charges filed in Princess of the Stars case

From AFP, Sept. 2, 2008

Criminal charges have been filed against officers of a Philippine shipping company after one of its ferries capsized, killing almost 800 people.

The Public Attorney’s Office, on behalf of the families of 13 of the deceased, filed charges of negligence and reckless imprudence resulting in multiple homicide against officials of Sulpicio Lines for the capsizing of their ferry in June.

The 23,000-tonne Princess of the Stars, carrying 850 passengers and crew, capsized after hitting a reef off the central island of Sibuyan on June 21 at the height of Typhoon Fengshen. Only 57 passengers and crew survived.

The sinking was the country’s worst maritime disaster for 20 years.

The charges, filed with the Justice Department, named the missing captain of the ship, Florencio Marimon, and the president, chief executive officer and other senior officials of Sulpicio Lines as respondents.

In the complaint, the office said the respondents should be held criminally liable for allowing the ship to set sail despite a warning by the Government weather station that a storm alert had been raised over the area it was heading.

It also cited the absence of any other ferries in the area of the storm as evidence of the company’s “absence of care and foresight.”

Last month, the Board of Marine Inquiry, which investigated the incident, blamed the captain and called for the company to be stripped of its franchise.

Marimon is missing and presumed dead.

The Wreck of the Erika

Several important catastrophes were omitted from Flirting With Disaster, a necessity that I regret. People have their “favorites,” often for good reasons. A reader in India pointed out that leaving out Bhopal was unfortunate, and I agree. The story is an important one, and I plan to remedy my omission with a separate write up.

A second omission is that of marine accidents. I took a step toward remedying that with the recent post about the June 2008 capsizing of the ferry Princess of the Stars in the Philippines. I take another step with this post, a discussion of the wreck of the Erika in 1999 that caused France’s biggest environmental catastrophe. This matter has finally come to resolution by the courts, although there remain some important unanswered questions.

Wreck of the Erika 1999 (Reuters)

Wreck of the Erika 1999 (Reuters)

In early December 1999, the chartered tanker Erika left Dunkirk with 30,000 tonnes (9,500,000 gallons) of heavy fuel oil bound for Livorno, Italy. En route, she encountered heavy seas and split in half 45 miles off of Pointe de Penmarch, southern Brittany, dumping two-thirds of her toxic cargo into the sea. Between December and March, 20,000 tonnes of the oil came ashore on 250-300 miles of French Biscay coastline. According to estimates, the spill killed between 75,000 and 300,000 sea birds, by far the worst such calamity ever recorded, devastated local tourism, and threatened fishing and salt production. It took many years and 200 million euros to clean up the damage, although the local ecology may take longer to recover, if it ever does.

The Erika was chartered by Total S.A., the global oil giant that now combines the businesses of Total, the French oil and gas company, Petrofina, and Elf Aquitaine. Total is one of the four “super majors,” with 96,000 employees and 2007 sales of €158.7 billion.

During the nine years this matter has been in the courts (the actual trial only began in February 2007), Total claimed that it had relied on documentation that the Erika was seaworthy despite her worrying maintenance record, according to court investigations. Although the tanker had been allowed to continue to sail subject to a review scheduled for a month after the accident, Erika violated Total’s own safety protocols, although other investigations showed that the expert measurements of the extent of Erika’s corrosion would not have been easy for Total to assess. Still, in light of Erika’s extensive visible corrosion and spotty repair record, why was she chartered in the first place?

It appears that the Erika was the only ship available in Dunkirk at the time, and this prompted Total’s decision-makers to subordinate safety to business demands. One has to wonder what was so urgent, however, since there does not appear to be a time sensitive business matter of such consequence that it justified reckless behavior, and Total’s own decision rules would have argued against using the Erika. Furthermore, under the E.U. rules that applied in 1999, the tanker should not have been allowed to leave port, according to the court’s findings.

Nevertheless, in 1999 relevant European maritime safety regulations and enforcement were relatively lax, considering that 70 percent of Europe’s oil was transported near the ecologically and economically vulnerable Brittany coastline, and improving safety would only increase oil costs by one percent according to a 1998 U.S. National Research Council study. E.U. regulations were subsequently changed, although much too late for Erika’s many victims.

On January 16, 2008, a verdict was finally rendered by a French court. Total and Erika’s owner, Giuseppe Saverese, and its manager Antonio Pollara, were all found guilty, as was RINA, the Italian company that had declared the Erika seaworthy. Total was fined 375,000 euros, a modest amount but the maximum allowable, and ordered to pay a share of nearly 200 million euros in civil damages. (Total had already voluntarily paid the more than 200 million euros needed to clean up the environmental damage and pump out the remaining oil from the wrecked tanker.)

After the verdict, Total fell back on the division of responsibilities between the charterer — who, under international maritime law is not responsible for inspecting the vessel — and the ship’s owners. They also continued to question whether their failure to follow their own procedures — which go beyond that required by law — can rightly form a basis for liability. These may well be valid legal arguments, though not necessarily valid moral ones, since Total clearly created their internal rules for good reasons and in light of existing regulations.

It also remains to be seen whether the potentially massive environmental law suits permitted by the court against the defendants will be successful. Total’s liabilities may only be beginning.

(Eleven defendants, including Erika’s captain, were found not guilty for criminal charges for reckless endangerment. Total S.A. was also found not guilty on this charge.)

For our purposes, it seems clear that Erika’s age, single hull construction, and many maintenance problems should have prompted serious worries about its safety while plying the vulnerable and often treacherous winter waters of the English Channel. While it is true that Erika was documented as seaworthy, Total clearly knew better.

Like the timing of the launch of the Space Shuttle Challenger, the reasons Erika had to sail are a mystery. Perhaps a reader of this blog has facts I lack to illuminate the answer to this fundamental question. Understanding reckless decision-making is essential to preventing the creation of harm. If you know anything, please let me know.

m/

The Sinking of the Princess of the Stars


The capsized Princess of the Stars

There were storm warnings, but the ferry sailed despite them. Seven stories high and nearly 24,000 tons, she was rated to handle Storm Condition 2 winds on the 20 hour journey from Manila to Cebu, the major city in the southern part of the Philippines, 355 miles away as the crow flies. On board were 865 people, 724 passengers and 141 crew, about 50 of them children, as well as a dangerous cargo (a subject to which we will return shortly).

On route, the ship encountered the fierce winds and massive waves of Typhoon Fengshen, which had been sweeping through the region but had not been expected to cross the ferry’s path. Typhoons are notoriously erratic, however, and in due course Fengshen’s mountainous seas swamped and then capsized the ship as she ran aground, tearing a large gash in her hull in the process, just off Sibuyan Island in Romblon Province, about halfway to her destination.

Only 56 survived.

No explanation has yet revealed why Captain Florencio Marimon — now among the missing — sailed that evening despite the approaching typhoon. Sulpicio Lines Inc. (SLI), the shipowners, have nevertheless sued the Philippine Atmospheric, Geophysical and Astronomical Services Administration (PAGASA) and two of its officials for “gross negligence and incompetence” in forecasting the path of Typhoon Fengshen from June 20 to June 21, which it blamed for the sinking of its ship.

However, typhoon warnings were in effect at the time of sailing, and one has to question whether SLI’s claim is little more than an attempt to dodge responsibility for the tragedy. (We will get to their other attempts to shift responsibility in a moment.)

Beyond the ill-advised and arguably reckless departure of the Princess of the Stars (Manila Archbishop Gaudencio Cardinal Rosales called it “the act of a stupid person,” and even Philippine’s President Gloria Macapagal Arrooyo stated that the ferry should never have sailed), the state of the safety systems on board the vessel were far from ideal. Many of the life vests were outmoded, known to run risks of face-down flotation. Furthermore, the ship’s safety video did not instruct passengers in the proper procedure to jump into the sea (this perilous act requires wrapping your arms tightly around the life vest to avoid neck injuries as the vest’s buoyancy forces it violently upward as you hit the water). In addition, passengers were not warned to stay clear of the dangerous steel accommodation ladders welded to the side of the ship (used to provide access to small boats) that could seriously injure or kill careless jumpers or destroy inflatable life rafts as they are deployed.

Survivor reports also revealed that life boats were tightly lashed to the deck, making it difficult for passengers and crew to deploy them in the twenty minutes after the storm hit before the ship capsized. Even then, a number of the life boats that were launched were swamped by the rough seas, and hundreds of passengers were still on board or below decks when the ferry capsized.

Still, all this might be explained away if not for the long history of such accidents in the Philippines, many of them involving Sulpicio vessels. The worst by far was the collision of the Dona Paz with a tanker in 1987 that killed 4,300 in the worst peacetime maritime disaster. Other Sulpicio accidents include the Dona Marilyn in 1988, and the Princess of the Orient in 1998. In total, Sulpicio has had 45 sea mishaps in the past 28 years according to retired rear admiral Benjamin Mata. (Mata — one of two such resignations by high ranking former naval officers — withdrew from his role in the Board of Marine Inquiry’s investigation of the incident after being accused of bias by Sulpicio.)

In spite of the numerous maritime accidents in the Philippines, not a single captain or shipowner has been held criminally liable. In addition, Sulpicio, uniquely, is the only passenger carrier that was dropped from membership in the Protection & Indemnity Club, a cooperative insurance venture that would otherwise have provided adequate coverage. According to retired Rear Admiral Amado Romillo (the second former navy officer accused by the shipowner of bias) “substandard management and maintenance” prompted Sulpicio’s ousting from the club.

Liability and insurance are particularly important because in addition to its passengers the Princess of the Stars was carrying a highly dangerous cargo for Del Monte Philippines, a subsidiary of the global food giant. Aboard ship was a 40 foot container carrying the highly toxic pesticide endosulfan, a 10 foot container carrying four other pesticides, carbofuran, propineb, metamidophos and niclosamide, and a large quantity of bunker fuel. Endosulfan is not only deadly, but it prone to accumulate in the body, and is banned in the EU. In fact, will be banned for use in the Philippines starting in September 2008, although it is still used in the United States.

In the wake of the accident (and after some wrangling over bank guarantees) SLI has signed a contract with Titan Salvage of Ft. Lauderdale, Florida, to remove the dangerous cargo from the capsized vessel, a step that must precede the recovery of the trapped bodies and the ship itself. However, toxicity has vastly complicated the recovery process, and runs the risk of turning the human tragedy into a massive environmental disaster as well. The United Nations, who responded to a Philippine call for assistance, has recommended extensive monitoring and careful protocols to avoid exposing salvage crews — not to mention the nearby population of Subuyan Island — to risk.

In a civil legal action, Sulpicio has moved to transfer the liability for the cleanup to Del Monte, claiming that they had not informed the shipping line of the toxic nature of its pesticide cargo. Del Monte refutes this claim.

Rico Cruz, terminal manager of the International Container Terminal Services (ICTS) of the Philippines contradicted Sulpicio’s cargo operations officer Tomas Gutierrez Jr.’s statement that the endosulfan cargo had not been properly labeled. “When it arrived into our yard, its official classification is DG6 meaning poisonous,” Cruz said during the Philippine Board of Marine Inquiry (BMI) into the sinking. He added that he had taken pictures of the shipment. However, SLI has moved to prevent ICTS from testifying during the government inquiry on the grounds that it would bias the civil law suits currently underway.

As for the victims and their families, MARINA, the Maritime Industry Authority of the Philippines, has only required that Sulpicio pay P200,000 per fatality (about $4,500) and P20,000 ($450) to each survivor. This works out to less than half of the $7.55 million cargo salvage cost.

And you wonder why these things keep happening.

m/

Terminal Failure: What really happened at British Airways’ new T5?

HeathrowTerminal5

London Heathrow

Fiasco, national humiliation, monumental cock-up were some of the terms used to describe the disastrous opening of British Airways spanking new Terminal 5 at London Heathrow Airport a couple of months ago. And recently the British Parliament heard evidence from management and staff about the now infamous baggage handling system at BA’s flagship terminal, supposed to be the crowning glory of the busiest passenger airport in the world.

Opened with great fanfare (and the Queen) at the end of March, pride quickly turned to embarrassment when its highly touted “state-of-the-art” baggage handling system didn’t work as expected. Tens of thousands of bags went missing, hundreds of flights had to be canceled, passengers were in the dark and the press had a field day. Even now the system doesn’t work as well as promised. What went wrong?

Let me first declare my personal interest in this topic. For one thing, I’m in London for the summer, and this city’s embarrassments are a welcome break from collapsing cranes in New York, and the U.S.’ ever-worsening financial problems, not that the UK papers aren’t filled with equal prophecies of doom and their own local dramas. Still, T5 is worth a look, since it is such a perfect case of the reasons we don’t seem to be able to learn from mistakes.

The truth is that we don’t yet know why things went so drastically awry at Terminal 5, even after years of planning and months of on-the-ground preparations. We do know that BAA, the operator of Heathrow airport, and BA, British Airways, were working together on Terminal 5, but apparently not all that well. We also know that unionized employees claim not to have been consulted about what needed to be done to get things right for the opening, and indeed, as they told members of parliament, concerns they voiced about potential problems well before the terminal officially opened were ignored by BA and BAA managers and key decision-makers.

As I argue in Flirting with Disaster, accidents are rarely accidental, and almost always prefaced by “weak signals,” those early indications — often dismissed by those in charge — that things might well be about to go seriously wrong. This is compounded by the fact that organizations routinely run into problems arising from major change, working with “outsiders,” and communications difficulties — none of which require rocket science to diagnose by just about anyone who has spent any time inside big companies or government departments.

So what does this tell us about T5? First, it seems likely — if not inevitable — that BA and BAA bigwigs knew well in advance that they were in trouble, and that meeting the deadline was unlikely at best. Large, complex projects are inevitably prone to delays from many causes, including “unknown unknowns” that are impossible to predict. Things are even worse when more than one chain of command is involved. But BA had stuck its neck out on the opening date, and was almost certainly going to be embarrassed if it was delayed. This is reminiscent of management at NASA who were hell-bent on launching the space shuttle Challenger on a given date and time, come hell or high water (with the tragic consequences the whole world watched live).

My guess is what happened at BA is what typically happens in this sort of scenario. The various top dogs, who would have to bear the embarrassment of a delayed opening (and let’s not forget that Her Majesty, no less, had been booked for the opening ceremony) told their senior underlings to “get it fixed, no matter what.” That heads would roll if they failed was implied, if not explicitly stated. (Such heads did roll, in fact, and then some.)

What also seems likely, however, is that the top of the two organizations did not pay sufficient attention to the inevitable warnings from these same underlings that the problems might not actually be solvable in the time remaining, edicts from on-high notwithstanding.

But something else must have been in play. The most oft-cited failure underlying the T5 debacle was a lack of staff training. But such an omission is hardly a subtle point. One cannot simply “forget” to train one’s staff on a new and complex system or, for that matter, forget to test such a system under high stress loads. Both BA and BAA are better than that, far better. After all, they successfully run one of the busiest airports in the world.

No, my guess (and it’s only a guess because a thorough investigation with the power to collect documents and compel testimony under oath has yet to occur) is that pride was the culprit here. The guarantee of embarrassment from a delay versus the mere possibility of embarrassment if things didn’t get fixed in time. And here, a common and very human response — so often behind the failure to heed those weak signals I mentioned — comes into play: denial of the real risks. Like the proverbial ostrich, a great many important heads were firmly buried in the sand.

In many past disasters, there are instances in which leaders are willing take huge risks to avoid embarrassment. Did that happen here? I’d certainly love to find out, and you’d think that the British public would want to know too.

On the other hand, people don’t seem to be looking very hard. In fact, everyone seems to be happy with the current non-explanation. The unions are off the hook with their “It never would have happened if they’d talked with us” lament. (Of course, we might ask “Where were the whistleblowers?” in this country with some of the strongest protections for such revelations in the public interest.)

BA and BAA are also off the hook. A few people have been sacked, so we have the emotionally satisfying scapegoats, and the two organizations can point fingers at each other, a convenient way of obscuring the fact that they are both to blame since T5 was always a partnership, and both sides had plenty of reasons and many years to work out their differences.

What is most interesting to me is that the newspapers have made a far bigger point of the fact that over 900 bags a day still “go missing” at T5 than the lack of any real explanation about why things went wrong in the first place. (Actually, the bags don’t disappear, they just miss their connection.) Compared to the thousands that ended up in Turin at the height of the debacle, this is small fry, and it is actually only about 20 percent worse than the Heathrow average — certainly a problem — but hardly worth top billing. Of all the issues that have plagued the startup, this appears to be one that has fact-based operational explanations.

Instead of continued outrage, everyone seems contented with Parliament’s non-investigation. And if you need a reason why these calamities continue to occur, now you have one: no one really wants to get to the bottom of them.

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Interview by Jeffrey Toobin of the New Yorker and CNN

Jeffrey Toobin covers legal stories for The New Yorker and CNN and I was very pleased to have him conduct this interview. Jeffrey has written a number of topical books on legal themes, such as the O.J. Simpson trial, the too-close-to-call election of Bush vs. Gore, the Clinton sex scandal and, most recently, a book about the U.S. Supreme Court. He graduated with honors from Harvard Law and edited their Law Review.

It was a pleasure to have some real air time (about 15 minutes) to discuss some of the issues in the book. Usually, my radio interviews have been brief, except for the BBC World Service and the marathon session on Coast-to-Coast AM with both Daniel and Michael Ellsberg.

Have a listen.

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