“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 isn't 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.
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 isn't sufficient that these affect corporate cash flows and the value of financial assets. For these to constitute a genuine threat to financial stability, it's necessary to assume that markets also fail to price these risks.
Though the enhanced greenhouse effect is global, weather remains local. It’s thus inherently implausible that a concatenation of local weather events across a bicoastal 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-19 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 20 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 percent and 85 percent of their market value. Nonetheless, the DAX 30 index of German blue-chip companies rose by 39 percent. 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.