The Fed is not a climate regulator
On Tuesday, January 11, the Senate Banking Committee held a audience on the renomination of Jerome Powell as Chairman of the Federal Reserve. If Powell is confirmed, the Fed will try to squeeze fossil fuel companies out of U.S. credit markets, the the wall street journal Editorial Committee warned the same day.
Powell wants banks to use “climate stress tests” when deciding on loan applications. In the abstract, this may seem sensible. Extreme weather events such as hurricanes, floods and wildfires inflict property damage and financial loss on businesses. Climate change can increase the frequency and severity of extreme weather events. Thus, one might assume that banks should “take into account” borrowers’ exposure to climate risk when assessing creditworthiness, setting interest rates and establishing collateral requirements.
A huge problem with Powell’s proposal is that it is extremely difficult for scientists, let alone bank executives, to isolate climate change risks from simple climate risks for specific companies operating in specific locations. . For example, did deep winter freezing cause major parts of the Texas power grid to shut down in February 2021 despite or because of global warming? Depend on what a scientist you ask. The Fed has no capacity to arbitrate and even less to “settle” the debate.
And even if such knowledge were available, extreme weather conditions and rising temperatures pose no danger to Bank balance sheets. As the Newspaper reminds us: “A Federal Reserve Bank of New York staff study last fall found that banks benefit from extreme weather events because they stimulate increased lending. From Newspaperit is editorial on the study from last November:
Examining disasters declared by the Federal Emergency Management Agency from 1995 to 2018, the [New York] Fed staff found “insignificant or small effects on the performance of US banks.” The disasters spurred demand for loans, which offset losses and boosted income. The revenues of large banks increased as they were exposed to disasters.
Local banks tend to avoid mortgages where floods are more frequent than flood maps predict, suggesting “local knowledge can also mitigate disaster impacts,” the authors say. Unlike the federal flood insurance program, banks have a financial motive to accurately calibrate disaster risk.
A more plausible rationale for stress testing is that climate policy may affect bank profits or even their solvency, as aggressive climate policies could bankrupt some of banks’ biggest borrowers, namely fossil fuel companies.
However, this rationale is hollow. Banks don’t need to be told by the Fed that climate activists want to bankrupt ExxonMobil. The real point of stress testing is not to identify banks‘ the risks associated with climate policy, but intensify fossil fuel companies‘ climate policy risks. In the Journal’s words:
Instead, the left wants the Fed to use stress tests to force banks to cut and eventually eliminate funding for coal, natural gas and oil development. Banks should adjust their balance sheets to take into account risks related to government climate policies such as mandates, regulations or carbon taxes. To pass the climate stress tests, banks would have to liquidate fossil assets.
Consider that for a moment. Denying credit to fossil fuel companies, or simply increasing their borrowing costs, would reduce their profitability and growth potential. Choking off their access to credit would also scare off investors, driving down stock prices. As corporate capital and credit ratings decline, their ability to avoid or resist hostile litigation, punitive regulations, carbon taxes, and other political attacks would also decline. Ultimately, shareholders of fossil fuel companies could lose their shirts. In Climate Speak, such deliberate destruction of private equity is referred to as “protecting shareholder value.”
Congress has never passed legislation authorizing the Fed to require banks to conduct climate stress tests. In fact, Powell’s proposal is reminiscent Operation Choke Point, the Obama administration illicit policy of pressuring banks to deny credit to legal businesses such as coin dealers, gun dealers and payday lenders. During a Senate Banking Committee hearing in March 2021, the American Enterprise Institute economist Benjamin Zycher warned:
The proposals that the Federal Reserve enforce a mandate that financial institutions assess climate “risks” represent a blatant effort to divert the allocation of capital from disadvantaged economic sectors by certain political interest groups pursuing ideological agendas. This would represent the return of Operation Choke Point, a past attempt to politicize access to credit, deeply corrosive to our legal and constitutional institutions.
At this week’s hearing, ranking member Sen. Patrick Toomey (R-PA) warned Powell that he was playing with fire. The Fed, Toomey explained, operates on the basis of an implicit bargain: the Fed enjoys “policy independence” on condition that it engages only “in areas in which it has a mandate.” Toomey continued:
The Fed is not mandated to advance politically charged causes that are irrelevant to its mandate, such as fighting global warming or promoting so-called racial justice. … Let me be clear – if this politicization continues unchecked – it will not end well for the Fed or for independent monetary policy. As the leader of the Fed, I hope you take this seriously and master it to protect the legitimacy and independence of the Fed.
There is a stress test that would align with the Fed’s statutory objectives – a test that assesses the financial risks to borrowers and, therefore, banks against inflation induced by a $3 trillion federal spending deficit. dollars per year. Not that I would support such a mandate, but at least a stress test organized around the concepts of budget deficit and inflation would give substance to the Fed’s famous policy independence, and might inspire other Democratic senators to acknowledge the fiscal responsibility concerns raised by Joe Manchin (WV) and Kyrsten Sinema (AZ).
In any event, substituting climate goals for the Fed’s traditional focus on economic growth and price stability is a bigger threat to US financial stability than climate change. For example, the Newspaper observes: “An irony is that anti-carbon government policies are leading to what some economists call ‘greenflation’ – an increase in commodity and energy prices on everything from oil and gas to lithium and copper. Greenflation has two causes:
Investment in fossil fuels has fallen sharply even though consumer demand has not diminished. Here comes the climate crisis in Europe, which has led to soaring energy costs. Meanwhile, government policies have boosted demand for green energy, but the supply of minerals needed to make batteries for electric cars, solar panels and wind turbines is lagging behind, driving up prices .
Climate policy depresses fossil fuel supply relative to consumer demand while increasing industrial demand for energy transition minerals (such as lithium, cobalt, copper and rare earths) relative to supply. Climate policy is also decreasing the supply of fossil energy faster than it is increasing the supply of renewable energy.
These results should surprise no one. The mining and processing infrastructure required to replace a rich in minerals energy system does not exist yet. No more than an effective permit system able to quickly approve billion dollar mining projects and thousands of new wind and solar installations.
Biden promises a prosperous transition from fossil fuels to renewable energy. So far it has been a transition from abundant and affordable to rare and unaffordable fossil fuels. Climate politics is also making America more dependent on OPEC for hydrocarbons and China for energy transition minerals.
Doesn’t anyone at the Fed, or in the administration, see the professional reputational risk of appropriating an economically ruinous, illegal, and unsustainable program?