The Cost of Safety

In a struggling economy many of us yearn for a safe harbor, and some are asking the government to provide such safety. But can we afford it?

In doing a standard cost benefit analysis of a problem the key question is whether or not an expense is worth the benefit that it may provide. For example:
Let's say that there is a 1% chance that my $20,000 car might be stolen. So 1% times $20,000 means that the estimated losses are equal to $200. This means that if I can spend less than $200 to protect my car from theft, it might just be worth it. But if the a car security system would cost me $500, then there just isn't enough benefit to cover the expense.

The same analysis can be used for big decisions as well. Let's imagine that there is a 30% chance that the economy will melt down if large banks were allowed to fail. This economic problem, if it occurred, would impact the amount of income that banks add to our national GDP (which is $13.84 trillion). Estimating that banks add up to 30% of our GDP, we could figure that a bank failure could lead to the loss of up to $4.15 trillion (30% * $13.8). But there is only a 30% chance that such an event would occur, so the real risk is 30% times the possible loss ($4.15 trillion), or $1.24 trillion. So in such a case, we should only be willing to spend $1.24 trillion to insure such a risk.

That math may be boring, but there is a fairly interesting point. The U.S. GDP is $13.84 trillion. If we lost everything in one year the most we could lose is $13.84 trillion, and the chances of that are effectively zero! So why are we willing to spend over $8.5 trillion to stop the economic crisis? $8.5 trillion is more than the cost of all U.S. wars ever fought! (see http://www.nowpublic.com/world/wall-street-bailout-so-far-exceeds-total-cost-all-us-wars)

The math doesn't add up, but the interest expense on the debt does. This is catastrophic in terms of the burden it places on taxpayers. It's time to say no every single budget increase.