Shortly before her nomination as Treasury secretary in the Biden administration, Janet Yellen appeared on a Bloomberg New Economy panel discussing the role of central banks as the world struggles to emerge from the Covid-19 pandemic. The panel revealed a sharp difference of opinion between Yellen and one of her predecessors – Larry Summers, President Clinton’s second Treasury secretary. “Don’t we think that central banks really need to be careful about holding out the idea that they are relevant to sectoral issues involving differentials between one sector or another like environmental protection?” Summers asked. The environment is not within central banks’ “proper remit,” Summers suggested; having the Fed make special efforts to buy green bonds was “a confusion.”
“On sustainable goals, I think it does make sense for supervisors to be taking the risks from both climate-related risks and the risk of changes in prices and stranded assets,” Yellen replied, articulating what has become the consensus among central bankers and financial regulators. As Villeroy de Galhau, governor of the Banque de France, puts it, “climate change is part of our mandate for financial stability, but also for monetary policy.” De Galhau’s bank was behind the creation of the Network of Central Banks and Supervisors for Greening the Financial System, founded in December 2017 on the second anniversary of the Paris Agreement.
Thanks to the Trump presidency, American regulators are coming late to the party. The Fed joined the greening network only after Trump’s election defeat. The exception is the Commodity Futures Trading Commission (CFTC), one of whose commissioners has compared the impact of climate change on financial markets to the 2008 subprime crisis. In September, the CFTC produced a 196-page report on climate risk and financial stability. Being first out of the blocks gives the CFTC climate bragging rights, and its report will likely serve as the reference point for the greening of financial regulation and the Fed under the Biden administration.
The CFTC report, Managing Climate Risk in the U.S. Financial System, is an important document. As has become standard, it construes two main types of climate risk as threats to financial stability: those arising directly from the physical impacts of man-made climate change and those arising from climate policies. It’s not sufficient that these affect corporate cash flows and the value of financial assets. For these to constitute a genuine threat to financial stability, it is necessary to assume that markets also fail to price these risks.
There is a tone of the lady doth protest too much to the report’s discussion of the physical impacts of climate change. “Like others, I see what is already happening – entire regions burned by increasing wildfire, larger storms, more frequent floods,” Bob Litterman, who chaired the committee responsible for the report and spent 23 years at Goldman Sachs in risk management, writes in the foreword. The only problem: the data don’t support Litterman’s claim. “When I hear climate change discussed it’s suggested that it’s a major reason and it’s not,” Scott Stevens of the University of California, Berkeley, told Michael Shellenberger in reference to last year’s California wildfires.
Litterman’s claim about larger storms is falsified by the data. Accumulated Cyclone Energy (ACE) measures the intensity and frequency of tropical storms and cyclones and indicates the damage potential of a storm season. According to Ole Humlum, global ACE data show no clear trend for the entire period from 1970. Bjorn Lomborg points out that 2020 was indeed an extraordinary year for hurricane activity – one of the weakest of the last forty years, with global ACE just 76% of the 1980-to-2010 average.
The CFTC report contains a chart showing a rising incidence of inflation-adjusted, $1 billion disaster events since 1980 – a function of the greater intensity and frequency of extreme weather events, the commission claims. This conclusion is a travesty, something one might expect from an activist NGO rather than a financial regulator. (In fact, Litterman is also a vice chair of the World Wildlife Fund.) As Lomborg explains in a 2020 paper, “all kinds of disasters are likely to become bigger as there are more people and more wealth in the path of danger,” in what is known as the Expanding Bull’s-Eye Effect.
The report’s fear-mongering purpose is evidenced by its promotion of the widely discredited RCP8.5 warming scenario in order to help “shape awareness among policymakers” – i.e., to scare them. The damaging effects of climate change are manifested through extreme weather. Though the enhanced greenhouse effect is global, weather remains local. It’s thus inherently implausible that a concatenation of local weather events across a bi-coastal continental land mass subject to different weather systems will wreak such havoc as to constitute a systemic shock to the financial system. There’s a sound of barrels being scraped at the report’s implication that Silicon Valley and Wall Street could be hit so badly by simultaneous but separate extreme weather events that they cause a catastrophic shock.
Perhaps the sole benefit of the Covid pandemic is showing just how resilient and adaptable humans are if they’re allowed to be. The report’s statement that a world racked by “frequent and devastating shocks from climate change cannot sustain the fundamental conditions supporting our financial system” isn’t supported by any evidence – and on examination turns out to be preposterous.
The report also presents a weak case for the second category of climate risk – those arising from the destruction of business value from climate-change policies. Climate policies are hardly new. Germany passed it first Renewable Energy Act twenty years ago, so it’s surprising that the CFTC didn’t analyze what impact these measures had on financial markets. The German power generators had been given free carbon credits, but from a peak in January 2008 to August 2015, the three quoted generators lost between 59% and 85% of their market value. Nonetheless, the DAX 30 index of German blue-chip companies rose by 39%. The market worked. No evidence of threats to financial stability there.
Much of the CFTC report consists of a financial regulator telling investors how to do their job – and making a mess of it. It recommends imposition of a mandatory, standardized disclosure framework, and then, in the same paragraph, says that the understanding of climate risk remains “at an early stage.” Companies are reluctant to disclose climate risk data because of concerns about being disadvantaged, the CFTC claims. Yet only a few pages before, it suggests that companies that do disclose would enjoy improved market confidence in their management, valuations, and cost of capital. Disclosure is essential, but ambiguity as to when climate change rises to the threshold of materiality is the primary barrier to disclosure. Got all that? As analysis, the report is an incoherent mess.
But to accuse the CFTC of making bricks without straw would be to miss the point. The CFTC makes no secret of seeing its job as finding ways to channel capital toward net-zero investments. When financial regulators and central bankers start playing climate politics under the guise of promoting financial stability, they lose focus on their core responsibility. Markets thrive on diverse, often conflicting, views of the future. They over-heat when a single view predominates. Savage corrections can follow. Perhaps that’s what Summers alluded to when he spoke of confusion. If so, confusion is what we’re in for over the next four years. And therein lies the true threat to financial stability.
Rupert Darwall is a senior fellow of the RealClear Foundation and author of THE CLIMATE NOOSE.