More experts, more bankruptcies?

bankfailure

My friend John Almandoz and I recently published a paper on the relationship between the proportion of banking experts on a bank’s board of directors and the likelihood that that bank will fail. A reader-friendly summary just appeared in the online edition of Harvard Business Review. Click HERE to take a look, and let me know what you think!

Illusory Redundancy Strikes Again

What my trip to the airport teaches us about why catastrophe happens.

I noticed the feeling of rain in the air as soon as I stepped out of my final afternoon meeting on this trip to New York. Since moving to Seattle, I have missed the powerful, dramatic summer thunderstorms that the East Coast produces, and I suspected that one was in store.

I had a few hours until I had to be at JFK, but it was too early to have dinner, so I decided to retreat to a cafe in nearby Flatiron for a respite from the heat and humidity.

A few minutes later, the deluge arrived. The rain hammered the street as well-prepared pedestrians hoisted umbrellas. It soaked the unprepared.

I was hoping to have dinner at a restaurant that was a fifteen-minute walk away. Burdened by a rolling suitcase, and lacking an umbrella or rain jacket, I decided to check on Uber.

When I first looked, the surge multiplier was around 2.0, but in minutes the rain and rush-hour commute caused it to skyrocket to nearly four (with long wait times to boot). I decided to simplify and grab dinner around the corner, scurrying from awning to awning to avoid a soak.

After a quick dinner, I checked in on Uber again. Still a surge multiplier of 4.0, which made the ride from Manhattan to JFK around $400, more than I wanted to spend.

But, I’ve lived in New York before, so I decided to use my go to backup option: the Long Island Rail Road and AirTrain. The rain let up a little, and I made my way to Penn Station—a few-block walk and a quick subway ride away. Commuters packed the station, some milling about waiting for more information about delays on their lines. But the train to Jamaica still seemed OK, so I purchased a ticket, rushed down to the track, and jumped on the 6:31 train with only a moment to spare. If everything went well, I’d arrive in plenty of time for my 8:45 flight.

But everything wasn’t going well. Instead of speeding out of Penn Station, the train just sat.

A few minutes later, the conductor announced, “I have just heard from the Station Master: we’re being held momentarily in the station.” Commuters groaned collectively—a momentary delay on a day like today was unlikely.

Their suspicions were well founded. In a few more minutes, the conductor announced that “due to weather-related signal problems near Jamaica, this train line is being suspended until further notice.”

There I sat, a victim of illusory redundancy, when a backup system is vulnerable to same disruption as the system it’s meant to protect. Illusory redundancy is all about unexpected correlations, in this case rain drove Uber’s increasing demand and caused signal failures on the LIRR.

Illusory redundancies lie at the core of many meltdowns. During Hurricane Sandy, for example, the storm surge destroyed a key substation and blacked out a large chunk of Manhattan. At the same time, the surge flooded NYU’s state-of-the-art hospital, located a few blocks uptown, disabling their backup generator and forcing the evacuation of critically ill patients.

Before the launch of the Space Shuttle Challenger, engineers at NASA assumed that having two O-rings on the potentially problematic solid rocket boosters provided sufficient protection: even though cold temperatures might affect one important seal, they argued, the second would provide a backup. Yet when the primary O-ring failed during the stress of the launch, hot gasses from the booster quickly eroded the backup, causing it to fail as well and leading to Challenger’s destruction.

And illusory redundancy doesn’t just occur in physical systems. During the financial crisis, products like auction rate securities, which once seemed safe and liquid because of the breadth of participants that traded them, froze as shocks simultaneously affected many financial institutions. Anyone relying on the redundancy of multiple participants quickly realized their folly.

I thought of these examples as I made my way off of the train and onto the main level of Penn Station. It was so crowded with commuters that police had shutdown the station and were preventing people from entering. Inside, I found a corner with a trickle of 4G internet and checked out the Uber situation – surge pricing had dropped to 1.2. I requested a pickup and raced up to street level to meet the driver.

Traffic was bad, and we didn’t get to the airport until 8:52. But I had one thing going for me – I knew that the same weather system that shut down the LIRR caused delays at JFK. I thought that I still had a chance.

incoming_flight
The incoming flight. Note the racetrack holding pattern in the top left.

After passing through security, I ran to my gate, and arrived just as the gate agent called my boarding group.

I was lucky – though I was surprised by illusory redundancy, unexpected correlations, in the form of flight delays, worked in my favor.

Knowing that New York can be virtually shut down by heavy rain, I might have headed straight to the airport to wait there at the first sign of rain. It certainly would have made for a less exciting afternoon.