Wall Street's latest Waterloo has been nothing if not educational. Apparently, the government, the financial community, and the business world more broadly are shockingly bad at estimating risk (as an insurance company, AIG was supposed to be in the business of measuring and accounting for risk).
The shock has left many wondering what's coming next. What other economy-threatening risks are we missing?
This financial meltdown reminds me of another, larger catastrophe in the works: the change in the earth's climate and what it will do to business and society.
Although those two challenges may seem worlds apart, there are three critical attributes of the financial crisis that are eerily similar to those of the climate crisis.
First, the buildup of financial risk was relatively slow-moving and diffuse. After a number of years, as banks divvied up the mortgages and became overexposed to one class of investment, nobody even knew what was on their books anymore. Similarly, the buildup of greenhouse gases in the atmosphere has taken 150 years and represents the most diffuse problem humanity has ever faced. Every aspect of society from businesses to homes to cars owns a sliver of the problem.
Second, bankers seemed to think that the party would continue forever. What else can explain such an impressive level of denial about how prepared homeowners were to pay back loans or how fast home values would need to continually rise to support the entire scheme?
For years, environmental challenges also appeared to be far off. Resources appeared infinite, like easy credit, and many people still seem to think so ("Drill, Baby, Drill!").
But readily available resources are dwindling. When that immovable truth meets the unstoppable force of rising demand from India and China, prices will rise... and fast.
The companies that best assess risk and get lean will profit from these constraints. Even though all banks are reeling, a few like Bank of America and JPMorgan did limit their mortgage exposure and swallowed competitors that ignored the signs.
Third, there appears to be little incentive for bucking the trend. No bank wanted to miss any of the run-up in the value of mortgage-backed securities. But banks that left the mania earlier, along with über-investor Warren Buffett, have fared far better.
With climate change and resource use, the equivalent would be a company's leaving the 200-year-old "energy is free and resources are infinite" party by redesigning products and processes to reflect a new, less abundant reality. Companies often focus only on the risks and costs of addressing environmental issues before their competitors do; they don't do a good job of measuring the upside or accounting for the risk of not acting.
* * *
Although the system faltered on financial issues, the private sector can, and must, lead us away from the precipice on climate change. In a few cases, companies are already on the path. Japanese automakers built smaller, more energy-efficient cars—not exclusively, but much more aggressively than Detroit—and they are handling the downturn much better.
While the "Big Three" automakers saw US sales plummet 23-30 percent in 2008 (versus 2007), Honda was down only 8 percent and Subaru's sales were actually up a tiny bit last year.
Even business leaders who are still uncertain about climate change should be measuring the risk and taking action accordingly. As oil billionaire T. Boone Pickens recently said about climate change, "I don't want to wait around until the house burns down till I decide whether it's a serious fire or not."
Are we all going to heed the very real warnings and avoid a societal and business meltdown that will make this financial crisis look tiny?
Not if we keep our heads in the sand about slow-moving but enormous problems, act like we can continue as we always have (ignore, baby, ignore), fear innovation and leadership, or debate and seek mediocre, but not great, solutions.
Time is running short—and there is no global environmental Fed or Treasury to bail us out.
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