11 Dec What can Kobe Earthquake tell us about the financial markets?
I went to Kobe during my 2012 Japan trip. In 1995, Kobe suffered a 7.2 magnitude earthquake which caused a loss of 6,000 lives. I was not interested in this event while I was in Japan, but I watched the episode on Seconds to Disaster that I gleaned lessons applicable to our financial markets.
Prior to this, Kobe was not known to be vulnerable to Earthquakes. The traditional Japanese houses were built with heavy tiled roofs to protect against typhoons. However, the Japanese were not totally oblivion to a possible earthquake so they constructed the Hanshin Expressway according to the strict building code to withstand against 8.1 magnitude earthquakes.
Uncovering the unknowns
The epicentre was at Awaji Island, 20km away from Kobe. It uncovered a subterranean fault line that links Awaji to Kobe that was never known before. This allowed the shocks to be propagated along the path of least resistance from Awaji to Kobe.
The Hanshin Expressway collapsed after the supposedly 8.1 earthquake-proof supports gave way during the 7.2 shock. They discovered the building code was not reviewed since 1964 and it did not account for such shallow shocks (16km beneath the surface).
The heavy-tiled roofs that were effective against typhoons collapsed easily when the weak wooden pillars gave way during the shocks. Most deaths occured in suburbs where traditional Japanese houses were in abundance. These houses accounted for 9 out of 10 deaths.
The city was not functional in minutes – wooden houses and broken gas lines fueled the fires. Water pipes were broken and firemen were helpless to put out the fire. Thousands were trapped under the collapsed heavy tiled roofs.
The Japanese learned the lessons and they have changed their building code 3 times after the earthquake. There were more reinforcements to the pillars and supports for houses and the expressway now.
In 2008, Lehman Brothers collapsed and sparked the start of the Financial Crisis. Mortgage backed securities were not known to the retail investors before this crisis. It was as unexpected as the Kobe Earthquake. Properties were known to be safe investments and similarly, the Japanese also expected their houses to keep them safe. The irony was that the things they expected as protection played a part to harm them. The heavily leveraged financial institutions had to unwind their positions and the Fed had to bail out companies.
Post crisis, people are calling for more regulation of the financial markets. In Japan, people called for stricter building codes and stronger reinforcements against earthquakes.
The world and the financial markets are too complex and have hidden dangers that are beyond the comprehension of human beings, or Taleb’s famously coined “Black Swans”. We do not know when the stars will align and the hidden dangers present themselves. There is more “unluckiness” that can harm us more than our skills can protect ourselves.
Interestingly, the documentary interviewed two survivors. Bus driver Fukumoto was driving on the Hanshin Expressway during the earthquake. He stopped his bus a few meters before the bridge collapsed. The front wheels were dangling free above the crack. He survived and became the most famous bus driver in Japan. The other one being interviewed was a Mother who survived the collapse of a traditional Japanese house. The 29-year old son who stayed in the same house did not survive. Now, she teaches people to survive earthquakes. All is not lost after a Black Swan event. There are people who win and some who lose. Do not underestimate the luck factor in life.