HOW RISKY IS RISK?

As we struggle through the worst economic slump since the Great Depression, the concept of risk keeps coming up. Why did so many financial experts overlook the riskiness of those “subprime” mortgages? And why did so many homeowners sign on for loans they could barely afford at interest rates with built-in escalation?

Part of the explanation is that many experts as well as ordinary folks were caught up in the housing bubble and figured the boom would never end. Real estate looked like a great investment, and for younger people the Depression was ancient history that never could be repeated.

But there’s more to the risk story. Many decisions in life depend on balancing risks. For example, it’s often considered risky to let children play outside or walk to school. On the other hand, outdoor exercise can help avoid the childhood obesity and Type 2 diabetes that are reaching alarming proportions. Often a risk is worth taking if it overcomes a still greater risk.

A 2005 book called “Freakonomics” poses the question of whether the parents of 8-year-old Molly are wise in forbidding her from playing at Amy’s house, where her parents keep a gun, but letting her play at another neighbor’s house, with a swimming pool in the backyard. Child death figures show that Molly is about 100 times more likely to die in a swimming accident than in gunplay at the other neighbor’s house.

The book says that “most of us, like Molly’s parents, are terrible risk assessors.” It quotes Peter Sandman, a risk communications consultant from Princeton, N.J., on how a single case of mad-cow disease in 2004 in the United States prompted an anti-beef frenzy. Mr. Sandman told The New York Times: “The basic reality is that the risks that scare people and the risks that kill people are very different.”

“Freakonomics” raises the question of why people fear flying more than driving. It’s not as simple as you might think. It says the per-hour death rate of driving versus flying is about equal, although most people spend a lot more time driving than flying. The book throws in the information that more people die in boating accidents than in airplane crashes, suggesting again that water is more dangerous than people think.

A risk miscalculation close to home threatens to cost Maine $20 million. State Treasurer David Lamoine invested that amount on the advice of a trusted Merrill Lynch consultant last August in subprime mortgage paper from Mainsail II, based in the Cayman Islands. Two Bear Stearns hedge funds had already crashed and mortgage defaults were mounting. The investment was frozen 13 days later and Mainsail II is in receivership.

Like Molly’s parents, Maine’s treasurer misjudged the risks.