A team of economists recently analyzed 20 years of peer-reviewed research on the social cost of carbon, an estimate of the damage from climate change. They concluded that the average cost, adjusted for improved methods, is significantly higher than even the most recent U.S. government figures.
That means greenhouse gas emissions will take a greater toll over time than regulators account for. As tools for measuring the connections between weather patterns and economic performance continue to evolve—and the interactions between weather and the economy increase costs in unpredictable ways—damage estimates have only increased.
It’s the kind of data that one might expect to set off alarm bells throughout the financial industry, which closely tracks economic developments that could affect stock and credit portfolios. But it was hard to see even a wave.
In fact, the news on Wall Street lately has been more about a retreat from climate goals than a renewed commitment. Banks and asset managers are withdrawing from international climate alliances and rubbing up against their rules. Regional banks are increasingly lending to fossil fuel producers. Sustainable investment funds have experienced continued crippling outflows and many have collapsed.
So what explains this apparent discrepancy? In some cases, it’s a classic prisoner’s dilemma: if companies move together to cleaner energy, a cooler climate will benefit everyone more in the future. But in the short term, each company has an individual incentive to profit from fossil fuels, making the transition much more difficult.
And when it comes to preventing climate damage in their own operations, the financial industry is having a really hard time grasping what a warming future will mean.
To understand what’s going on, put yourself in the shoes of a banker or wealth manager.
In 2021, President Biden brought the United States back into the Paris Agreement and his financial regulators began issuing reports on the risks that climate change poses to the financial system. A global pact of financial institutions has made $130 trillion in pledges to cut emissions, confident that governments would create regulatory and financial infrastructure to make those investments profitable. And in 2022, the Inflation Reduction Act was passed.
Since then, hundreds of billions of dollars have flowed into renewable energy projects in the United States. But that doesn’t mean they’re a safe bet for people who get paid to develop investment strategies. Clean energy stocks were hit by high interest rates and supply chain issues, leading to the shutdown of offshore wind projects. If you had bought some of the largest solar exchange-traded funds in early 2023, you would have lost about 20 percent of your money while the rest of the stock market was soaring.
“When we think about how best to pivot your portfolios in a positive direction, that’s really difficult,” said Derek Schug, head of portfolio management at Kestra Investment Management. “Over a 20-year period, these will probably be great investments, but if you look at it over a one- to three-year period, it’s a little more challenging for us.”
Some firms target institutional clients, such as: B. Pension funds for public employees who aim to combat climate change as part of their investment strategy and are willing to accept short-term losses. But they are not the majority. And in recent years, many banks and asset managers have shied away from putting on a climate label for fear of losing business from states that frown on such concerns.
Furthermore, the war in Ukraine has confounded the financial case for supporting a rapid energy transition. Artificial intelligence and the trend towards greater electrification are increasing the demand for electricity, and renewable energies cannot keep up. So banks continued to lend to oil and gas producers who were making record profits. JPMorgan Chase Chief Executive Officer Jamie Dimon said in his annual letter to shareholders that it would be “naive” to simply stop oil and gas projects.
All of this is about the relative attractiveness of investments that would slow climate change. What about the risk that climate change poses to the investments of the financial industry itself, through stronger hurricanes, heat waves that cripple power grids, and wildfires that devastate cities?
There is evidence that banks and investors are pricing in some physical risk, but also that much of it still lurks unnoticed.
Last year, the Federal Reserve asked the country’s six largest banks to examine what would happen to their balance sheets if a major hurricane hit the Northeast. A summary last month reported that institutions found it difficult to assess the impact on loan default rates due to a lack of information on property characteristics, their counterparties and, in particular, insurance coverage.
Parinitha Sastry, an assistant professor of finance at Columbia Business School, studied unstable insurers in states like Florida and found that coverage was often much weaker than it appeared, making mortgage defaults more likely after hurricanes.
“I’m very, very worried about this because the insurance markets are this obscure weak link,” Dr. Sastry. “There are parallels to some of the complexities in 2008, where there is a weak and unregulated market that impacts the banking system.”
Regulators fear that not understanding these implications could not only cause trouble for a single bank but could even lead to a contagion that would undermine the financial system. They have put in place systems to monitor potential problems that have been criticized by some financial reformers as inadequate.
But while the European Central Bank is incorporating climate risk into its policies and oversight, the Federal Reserve is refusing to take a more active role, despite signs that extreme weather is fueling inflation and high interest rates are slowing the transition to clean energy.
“The argument was, ‘Unless we can convincingly demonstrate that it’s part of our mandate, Congress should deal with it, it’s none of our business,'” said Johannes Stroebel, a finance professor at New York University’s Stern School of Business .
Ultimately, this view may prove to be correct. Banks are in the business of risk management, and as climate forecasting and modeling tools improve, they may stop lending to companies and places that are clearly at risk. But that only creates more problems for people there as credit and business investment dry up.
“One can conclude that it does not pose a threat to financial stability and large economic losses can still occur,” noted Dr. Stroebel.
While it remains difficult to assess where the risks lie in one’s portfolio, a much shorter-term uncertainty looms: the outcome of the US elections, which could determine whether further action is taken to address climate problems or whether existing efforts are rolled back. An aggressive climate strategy might not perform as well during a second Trump administration, so it might seem prudent to wait and see how it will play out.
“Given the way our system has evolved so far, it is moving so slowly that there is still time to get over the proverbial line,” said Nicholas Codola, a senior portfolio manager at Brinker Capital Investments.
John Morton served as a climate advisor to Treasury Secretary Janet L. Yellen before rejoining Pollination Group, a climate-focused advisory and investment management firm. He has observed that large companies are hesitant to make climate-sensitive investments as November approaches, but says that “two things about this hypothesis are wrong and quite dangerous.”
First, states like California are adopting stricter rules for disclosing carbon-related finances and could tighten them even further if Republicans win. And second, Europe is gradually introducing a “carbon border adjustment mechanism” that will penalize polluting companies that want to do business there.
“Our view is, be careful,” Mr. Morton said. “You will be at a disadvantage in the market if you still have a large amount of CO2 in your hand in 10 years.”
But right now, even European financial institutions are feeling the pressure from the United States, which, while offering some of the most generous subsidies yet for renewable energy investments, has not put a price on carbon.
Global insurance group Allianz has laid out a plan to direct its investments to prevent warming above 1.5 degrees Celsius by the end of the century if everyone else did the same. But it’s difficult to tilt a portfolio toward climate-friendly assets while other funds are taking on polluting companies and impatient clients are making short-term gains.
“That is the biggest challenge for an asset manager, to really take the customer along,” said Markus Zimmer, economist at Allianz. Asset managers do not have sufficient tools to shift money from polluting investments to clean investments if they want to stay in business, he said.
“Of course it helps if the financial industry is somewhat ambitious, but you can’t really replace the lack of action by policymakers,” added Dr. Room added. “Ultimately, it’s very difficult to navigate.”
Recent research suggests that benefits are greater when decarbonization occurs faster, as the risk of extreme damage increases over time. But without a consistent set of rules, someone has to reap the immediate gains and penalize those who don’t – and the longer-term result is negative for everyone.
“The worst thing is when you set your business model for 1.5 degree compliance and it hits three degrees,” said Dr. Room.
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2024-06-20 09:01:30
www.nytimes.com
