Foolproof

Foolproof Plot Summary

Introduction

Throughout human history, our quest for safety has been relentless and ingenious. From building levees along rivers to creating central banks that stabilize economies, we have developed increasingly sophisticated systems to protect ourselves from nature's fury and our own financial follies. Yet time and again, these very protections have led to greater catastrophes when they eventually fail. The early 20th century Progressive Era saw Americans embrace the belief that enlightened managers could engineer away risk, whether in forests or financial markets. A century later, both devastating wildfires and the 2008 financial crisis revealed the limitations of this approach. This paradox of safety - that our protective measures often create new vulnerabilities - appears across domains as diverse as forest management, financial regulation, automobile design, and flood control. At its heart lies a fundamental insight about human behavior: when we feel protected, we take more risks. Drivers with antilock brakes drive faster in hazardous conditions. Banks lend more freely when they believe central banks will rescue them in a crisis. Homeowners build in floodplains when levees make them feel safe. By exploring these patterns through vivid historical examples, we'll discover how safety systems interact with human psychology to create unexpected dangers, and how we might design more resilient approaches that acknowledge our tendency to adapt to perceived safety.

Chapter 1: Progressive Era: Engineering Safety in an Unpredictable World

The early 20th century marked a pivotal shift in how Americans approached chaos and uncertainty. Two significant disasters - the financial Panic of 1907 and the devastating forest fires of 1910 - transformed public attitudes toward risk management. Before these events, Americans had largely accepted bank panics and forest fires as inevitable byproducts of a civilization pushing against its physical and industrial frontiers. The United States had endured more than a dozen financial panics since its founding. Though central banks could have prevented many of these crises by lending to banks besieged by depositors, Americans' deep suspicions of centralized power led them to reject such institutions twice in the 18th and 19th centuries. The Panic of 1907 changed this calculus. Senator Robert Owen, who had personally experienced financial ruin in earlier panics, became a fervent advocate for a central bank, declaring: "It is the duty of the United States to provide a means by which the periodic panics which shake the American Republic and do it enormous injury shall be stopped." Similarly, the devastating fires of 1910 altered America's relationship with natural disaster. These fires burned across Montana, Idaho, and Washington, consuming nearly five thousand square miles of forest and killing at least eighty-five people. Gifford Pinchot, a confidant of Theodore Roosevelt and the first chief of the U.S. Forest Service, declared: "Today we understand that forest fires are wholly within the control of men... The first duty of the human race is to control the earth it lives upon." These twin disasters coincided with two powerful social forces that elevated the belief that enlightened managers could foolproof society. The first was astonishing advances in the social and natural sciences. Economics was becoming more scientific, with Alfred Marshall's influential Principles of Economics making famous the supply and demand curves that imposed visual order on seemingly random behavior. Meanwhile, medicine was achieving similar breakthroughs, with Paul Ehrlich predicting that mankind would eventually develop a "magic bullet" for every pathogen. The second force was political. As America's economy industrialized, more wealth accumulated in the hands of millionaire capitalists and giant corporations, producing a backlash. The result was Progressivism - the philosophy that government could be a force for both equity and efficiency. Under Presidents Theodore Roosevelt and Woodrow Wilson, laissez-faire retreated as the guiding principle of economic management. The Federal Reserve Act, signed into law in 1913, created a central bank to prevent financial panics, while the Forest Service transformed into an organization devoted to fighting fires. A century later, both panics and forest fires remain with us. The global financial crisis of 2008 and increasingly devastating wildfires demonstrate that our efforts to create safety often plant the seeds for future disasters. This fundamental contradiction in humanity's quest for stability illustrates how our efforts to make surroundings safer trigger offsetting behavior that frustrates those efforts.

Chapter 2: Volcker's Dilemma: How Saving the System Created Future Risk

In the 1970s and early 1980s, the global economy faced a series of interlocking crises that threatened to bring down the entire financial system. At the center of this storm stood Paul Volcker, who became Federal Reserve Chairman in 1979 facing three major problems: double-digit inflation, Latin American countries drowning in dollar-denominated debt, and American banks that had lent them the money teetering on the edge of collapse. Volcker's first challenge was inflation, which had been rising since the 1960s and hit double digits after the Iranian revolution sent oil prices soaring. He crushed it by pushing interest rates to an unprecedented 20 percent. This brutal medicine triggered a deep recession but successfully broke inflation's back. However, these high interest rates threatened Latin American countries that had borrowed heavily in dollars. In August 1982, Mexico was running out of foreign currency to service its bank loans. If Mexico defaulted, many American banks would instantly become insolvent. Volcker orchestrated a remarkable series of interventions. He arranged for Mexico's finance minister, Jesús Silva Herzog, to meet with creditor banks in New York. Herzog dramatically told the bankers, "We're out of money, and we think it's in your interest not to force payment. In fact, we think it's necessary for you to lend us some more money." The banks agreed to roll over Mexico's debts and lend enough to pay the interest, preserving the fiction that Mexico was solvent. Meanwhile, regulators decided not to force banks to write down their loans to their true value, giving them time to earn enough profits to absorb the losses. Another crisis soon loomed when Continental Illinois, America's seventh-largest bank, faced collapse in 1984. Though the Fed wasn't supposed to lend to unhealthy banks, Volcker feared that if Continental went down, several even bigger banks would follow. He not only lent to Continental but urged the Federal Deposit Insurance Corporation to protect deposits beyond the $100,000 cap. This prompted a congressman to observe that a new class of banks now existed: "too big to fail." Volcker's actions in 1982 and 1984, along with similar interventions by his successor Alan Greenspan in 1987 and 1989, set the template for how policymakers would react to crises for twenty-five years. The Fed would keep inflation low and stable while doing whatever it could to prevent both recessions and financial collapse. But this pattern had unintended consequences that troubled Volcker. As he remarked in 1989: "We seem to be on something of a hair trigger in using these tools. This leaves me with the disturbing question of whether by using these tools repeatedly and aggressively we end up reinforcing the behavior patterns that aggravate the risk in the first place." Volcker's concern proved prescient. By making the economy seem safer, the "Great Moderation" of the subsequent decades changed attitudes about debt. Between 1979 and 2008, business and household debt rose from 95 percent to 171 percent of GDP. The system had learned that the economy was largely insulated from its most destabilizing elements, and that stability lulled everyone into taking on more risk. This wasn't because individuals and institutions were bailed out - they usually paid a price for excessive risk-taking. Rather, the system as a whole learned that stability was the new normal, making risk-taking seem less dangerous than before.

Chapter 3: Risk Compensation: When Safety Features Change Human Behavior

On October 17, 2010, football fans witnessed an unusually violent day in the NFL. In three different games, five players suffered concussions from helmet-to-helmet hits. The most notorious incident occurred when Pittsburgh Steelers linebacker James Harrison drove his helmeted head into Cleveland Browns receiver Josh Cribbs, who collapsed in a quivering heap. Minutes later, Harrison did the same to another Browns player, Mohamed Massaquoi. The NFL responded with hefty fines and threatened suspensions for similar hits in the future. This controversy highlighted a paradox that has long preoccupied safety experts: safety equipment designed to protect people can sometimes lead to more dangerous behavior. Mike Ditka, a former Chicago Bears coach, suggested a radical solution: "I don't think people would strike with the head nearly as much if you didn't have a helmet on your head. You would learn to strike with a thing called shoulder pads." The history of football helmets illustrates this dynamic perfectly. When football was first played in 1869, players wore no protective gear. The first head protection consisted of leather caps designed primarily to protect the ears from being yanked. In 1939, the John T. Riddell Company introduced the first plastic-shell helmet, which was harder and longer-lasting than leather. The next year, they added the first face mask. While helmets reduced some injuries, coaches soon saw them as weapons. Woody Hayes, the legendary Ohio State coach, told reporters in 1962: "We teach our boys to spear and gore. We want them to plant that helmet right under a guy's chin." This tactic led to a dramatic increase in spinal injuries. A study comparing football injuries from 1959-1963 to 1971-1975 found that while deaths declined 10 percent, permanent quadriplegias more than tripled and broken necks quadrupled. The authors blamed "the development of a protective helmet-face mask system that has effectively protected the head, and by doing so has allowed it to be used as a battering ram." This phenomenon, known as "risk compensation" or the "Peltzman effect" (named after economist Sam Peltzman), occurs across many domains. When people feel safer, they often take more risks, offsetting some or all of the safety benefit. Peltzman first documented this in a controversial 1975 paper examining automobile safety regulations. He concluded that while driver deaths had declined, pedestrian injuries and property damage had increased because drivers were driving more recklessly with safety features. The clearest evidence of risk compensation came with antilock brakes (ABS). On test tracks, ABS dramatically reduced stopping distances and crashes. But real-world studies found virtually no reduction in accidents. One study of a Munich taxi company found ABS-equipped vehicles had just as many collisions as others. Drivers with ABS were driving faster and braking harder. Other research found cars with ABS had fewer frontal collisions but more rear-end collisions and run-off-the-road incidents. Adrian Lund of the Insurance Institute for Highway Safety explains that risk compensation depends on how safety technology affects the driving task: "When I finally got my mother-in-law to wear a seat belt, she went to get out of her car and the belt stopped her. That's what happens with the belt. It doesn't affect the driving task. But if you give people studded snow tires, we know from empirical evidence they will drive faster on snow." This insight helps explain why eliminating concussions in football has proved so difficult. Studies comparing American football with rugby (played without hard helmets) found that players hit one another with twice the energy in American football. The helmets allow players to hit harder without immediate pain, while fans expect a more violent spectacle.

Chapter 4: Financial Crisis: The Shattering of Perceived Safety

The global financial crisis of 2008 demonstrated how quickly a sense of safety can transform into panic. For twenty-five years prior, the economy had experienced the "Great Moderation" - a period of low inflation, mild recessions, and successfully contained financial turbulence. This stability bred a dangerous complacency that manifested in excessive risk-taking throughout the financial system. At the heart of the crisis was the creation of supposedly "safe" assets. Gary Gorton, an economist at Yale University, explains that the financial system constantly seeks to create assets so safe that their holders don't need to know anything about them - what he calls "information insensitive" assets. Historically, bank deposits served this purpose. But as demand for safe assets grew, especially from foreign investors, Wall Street created substitutes like mortgage-backed securities (MBS) and collateralized debt obligations (CDOs). These new instruments were engineered to seem as safe as bank deposits but weren't truly safe. Lewis Ranieri, who pioneered mortgage-backed securities, said their beauty was that buyers "did not have to know much, if anything, about the underlying mortgages. You have just taken an ugly object, a home loan, and dressed it up." Companies like AIG sold insurance on these securities, further enhancing the illusion of safety. By 2007, these supposedly safe assets had replaced traditional bank deposits as the foundation of the financial system. When subprime mortgage defaults began mounting in 2007, this sense of safety shattered. Investors weren't sure which securities contained bad mortgages or who held them, so they pulled back broadly. The crisis reached its apex when Lehman Brothers declared bankruptcy in September 2008. This shocked the financial world because it violated a deeply held assumption: that the government would never allow a major financial institution to fail. The collapse of Reserve Primary Fund, the world's oldest money market mutual fund, illustrated how devastating the loss of perceived safety can be. The fund held $785 million in Lehman Brothers debt, representing just 1.2% of its assets. When Lehman failed, the fund "broke the buck" - its share price fell below the sacrosanct $1.00 value. This triggered massive redemptions across all money market funds, regardless of their Lehman exposure. Within a week, investors withdrew $349 billion from money market funds, which in turn stopped buying commercial paper, the short-term IOUs that many companies relied on for funding. The panic subsided only when the Treasury Department guaranteed money market funds and the Federal Reserve began buying commercial paper. But the damage was done - the financial system had experienced a modern-day bank run. As Gorton observed, "Like the classic panics of the 19th and early 20th centuries, this one was because of a lack of information." Investors couldn't distinguish between good and bad assets, so they fled from everything. This crisis revealed the fundamental contradiction in our quest for financial stability. The very success of central banks in creating a stable environment had encouraged behaviors that made the system more fragile. The financial innovations designed to make the system safer had instead created new, hidden vulnerabilities. When the illusion of safety was pierced, panic ensued, demonstrating that our efforts to eliminate risk often just transform it into something more dangerous.

Chapter 5: Natural Disasters: The High Cost of Taming Mother Nature

When Superstorm Sandy struck the New York region in October 2012, it left behind flooded subways, rivers running down Manhattan's streets, and millions without power. At $70 billion, it became the second-costliest storm in American history after Hurricane Katrina. While many linked Sandy to climate change, the principal reason for its devastating impact was simpler: millions of productive, affluent people lived and worked in a place that is inherently dangerous. New York's vulnerability to hurricanes was well-documented. Nicholas Coch, a geologist at City University of New York, had spent his career researching hurricanes that struck the region. The Great New England Hurricane of 1938, nicknamed the Long Island Express, carved out ten new inlets between Fire Island and East Hampton and destroyed towns throughout Rhode Island and Connecticut. Yet even that devastating storm did "just" $5 billion worth of damage (in 2014 dollars). What changed between 1938 and 2012 was not primarily the climate but human development. The cheap wooden cottages along the shores of Long Island and New Jersey had been replaced by multimillion-dollar year-round residences. Global investment banks had built towering headquarters throughout Manhattan. Most residents either didn't know they lived in the path of a hurricane or didn't care, since hurricanes didn't come along that often. This insouciance virtually guaranteed that the next storm would inflict enormous damage. This pattern repeats across many types of natural disasters. Roger Pielke, Jr., a political scientist who studies natural disasters, has documented how economic development explains the rising toll of hurricanes, floods, and wildfires. By "normalizing" historical disasters - estimating how much damage they would cause with today's population and development - Pielke has shown that the Great Miami Hurricane of 1926, which cost $1 billion (in 2011 dollars) at the time, would cost around $188 billion today. The Mississippi River provides a classic example of how efforts to tame nature can backfire. Since the early 1700s, settlers built levees to contain flooding. After devastating floods in 1927, the Army Corps of Engineers embarked on massive flood control projects. These efforts were justified through cost-benefit analysis that factored in the increased farming, industrialization, and development such construction would make possible in the floodplain. However, as Gilbert White, a government geographer, pointed out in 1942, this created what became known as the "levee effect" - the tendency of humanity to feel protected by levees and build up more property in their shadows. White compiled numerous examples of flood protections being overwhelmed. After Hurricane Betsy ravaged New Orleans in 1965, the Army Corps strengthened the region's levees, leading to more development that was then exposed to Hurricane Katrina forty years later. This self-reinforcing cycle of protection and development ensures that natural disasters keep growing in scale. Chesterfield, a suburb of St. Louis, spent $2.5 million in the 1970s and '80s to strengthen a levee enough to withstand a hundred-year flood. This qualified local businesses for federal grants and relieved them from having to buy flood insurance. But in 1993, the Missouri River crested six feet above the previous record, breaching the levee and flooding the airport and 500 businesses. Chesterfield's response? It doubled down, rebuilding the levee to a five-hundred-year standard, which led to development in the valley doubling to six million square feet.

Chapter 6: Monetary Integration: From Gold Standard to Euro Crisis

For centuries, savers have sought ways to ensure that money lent to borrowers in different countries would maintain its value. This quest for monetary stability has repeatedly led to international monetary systems that initially create prosperity but ultimately end in crisis. The gold standard of the 19th century and the euro of the late 20th century represent two of history's most ambitious attempts to create monetary stability across borders. In 1821, after the Napoleonic Wars, Britain made the pound sterling convertible on demand to gold. Throughout the 1800s, countries that adhered to the gold standard found it easier to borrow from British investors. By promising to repay in either sterling or dollars backed by gold, American borrowers attracted a torrent of British capital to finance canals, railroads, and other economic projects. The gold standard served as a "good housekeeping seal of approval," as monetary historian Michael Bordo put it, carrying moral overtones that persist among gold's followers today. However, the gold standard had a dark side. By making it easier to borrow, it also made it easier to run up crippling debts. Argentina joined the gold standard in 1867, and between 1870 and 1889, capital equivalent to 19% of its GDP flowed in. But when Argentina couldn't repay these debts, it suspended its commitment to gold, foreign savings fled, and the economy collapsed. More fundamentally, the gold standard required painful economic adjustments that some countries found intolerable. If a country experienced inflation, it would see its costs rise and exports fall. As gold supplies dwindled, it would have to raise interest rates and cut government spending, driving down prices and wages through deflation - an extremely painful process. The gold standard collapsed during the Great Depression, but the desire for monetary stability persisted. After World War II, the Bretton Woods system fixed the dollar to gold and other currencies to the dollar. When this system broke down in the early 1970s, Europe set out to restore fixed exchange rates. France harbored particularly unpleasant memories of the franc's weakness in the 1920s. Valéry Giscard d'Estaing, France's president in the late 1970s, associated the currency stability of the gold standard with steady growth: "With their roots in a rural economy and their cultural leaning towards the fundamental values of savings and thrift, the French... thrive on stable money." The path to the euro began with attempts to peg European currencies to one another. But speculators regularly tested governments' commitment to maintaining the low inflation and balanced budgets necessary for stable currencies. In 1992, a devastating speculative attack forced Britain, Spain, and Italy to devalue their currencies. While Britain thrived with a cheaper pound, the rest of Europe concluded that only a single currency could end such crises. In 1999, the euro was launched. The euro initially appeared to be a remarkable success. Interest rates in peripheral economies like Greece, Ireland, Italy, Portugal, and Spain plummeted to German levels. Northern European banks eagerly lent to southern borrowers, confident that the traditional risks had diminished. But this confidence proved to be the euro's undoing. Previously, fear of devaluation had provided a spur to domestic reform in weaker countries. With the euro, that fear and spur were gone. Greece abandoned pension reforms, Spain's labor market remained rigid, and both countries saw wages rise faster than productivity. The illusion of safety shattered in 2009 when a new Greek government revealed that previous administrations had lied about budget deficits. In October 2010, German Chancellor Angela Merkel insisted that private investors in government bonds would have to take losses in future bailouts. This "Deauville Declaration" became Europe's "Lehman moment" - northern investors realized they now faced the risk of default rather than mere depreciation. Interest rates on southern government bonds skyrocketed, and northern savers yanked their money from southern banks.

Chapter 7: Balancing Safety with Innovation: Finding the Right Risk Level

How much safer should we make the world? This sounds like a ridiculous question - as safe as possible, right? But what if making us safer also makes us worse off? This fundamental question requires examining the role of fear and risk in human progress. Fear is indispensable to survival, yet not all of us feel it to the same extent. Some people would never bungee jump or cash in a life insurance policy to open a restaurant, while others go through life convinced that bad luck happens to other people. These differences are partly innate, as demonstrated by neuroscientist Antonio Damasio's research on patients with damage to the brain's frontal cortex. These patients, lacking the emotional response to risk, continued to make poor decisions even when they intellectually understood the consequences. However, fear is a two-edged sword. It keeps us from taking foolish risks that hurt us, but it can also prevent us from taking risks that could make us better off. This dilemma is particularly evident in entrepreneurship. Most new businesses fail within five years, yet some people start them anyway. Research by Lowell Busenitz and Jay Barney found that entrepreneurs are far more likely than managers to suffer from overconfidence. This trait, while seemingly irrational, enables entrepreneurs to neutralize uncertainty and persuade others to join their ventures. This risk-taking is essential for economic growth. Millions of enterprises open each year, and most fail. Economies grow because the survivors succeed so well that they make up for all the losers. While these failures may be painful for individuals, they are in aggregate good for society. The failure of a company seldom hurts anyone beyond its shareholders and employees, while a successful one yields products and innovations that everyone enjoys. The challenge comes when risk-taking reaches a point where the entire country is exposed. This is what distinguishes routine failure from a systemic crisis. The best financial system nurtures good risks while preventing risk-taking from creating systemic crises. But separating good from bad risks is easier said than done. Economist Aaron Tornell and his colleagues have studied this tradeoff by comparing the experiences of India and Thailand between 1980 and 2002. India had a highly regulated economy with government-owned banks and tight controls on lending. Thailand welcomed foreign investment and had mostly privately owned banks that were largely free to lend as they wished. The result was rapid growth in Thailand, followed by a catastrophic financial crisis in 1997. Yet despite this crisis, Thailand ended the period far richer than India - its GDP per capita grew 162% compared to India's 114%. This suggests that the policies that promote growth may also lead to financial excesses and crises. Financial liberalization generates more lending at lower cost, encouraging investment. Even bailouts may not be entirely bad - lenders who expect to be bailed out will lend more cheaply, encouraging growth. The bailout becomes the bill taxpayers pay for the benefits that easy finance generated in prior years. Similar tradeoffs exist in other domains. Society's aversion to nuclear power has led to greater reliance on fossil fuels, causing thousands of deaths from pollution. Studies show that nuclear power has the lowest fatality rate per unit of energy produced, yet we fear it most because of the catastrophic potential of a meltdown. This illustrates how we often focus on the maximum hypothetical deaths rather than the likeliest number.

Summary

Throughout history, humans have sought to create safety and stability in an inherently dangerous and unstable world. From the Progressive Era's faith in scientific management to the Federal Reserve's efforts to tame the business cycle, from fire suppression in forests to levees along rivers, we have repeatedly tried to engineer away risk. Yet these efforts often lead to greater catastrophes when they eventually fail. This paradox - that stability breeds disaster - stems from how safety changes behavior. When we feel protected, we take more risks. Banks lend more freely when they believe the Fed will rescue them in a crisis. Homeowners build in floodplains when levees make them feel safe. Drivers go faster when their cars have antilock brakes. This pattern repeats across domains as diverse as finance, forestry, medicine, and transportation. The Great Moderation of 1984-2007 exemplifies this dynamic: twenty-five years of economic stability led to a massive buildup of debt that culminated in the financial crisis of 2008. The challenge we face is not to eliminate all risk - that would stifle innovation and growth - but to distinguish between good risks that foster progress and bad risks that threaten the entire system. We need approaches that allow for small-scale failures while preventing catastrophic ones, that account for how humans actually respond to risk rather than how we wish they would respond, and that recognize that some level of failure is not just inevitable but necessary for adaptation and learning.

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Greg Ip

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