Careful What You Wish For
Capital Thinking • Issue #752 • View online
The title of this post is “unintended consequences.”
Here is the real question: How is it that the government has the power to force the financial system de-fund politically unpopular industries, under the guise that they might be “risky?”
Do we not have a nearly constitutional right to bet on an industry, be wrong, and lose a lot of money?
When everyone else is shunning so-far legal fossil fuels fearing government action, do we not have a right to take the contrarian bet?
Well, no.
And here is the really interesting story of a dramatic expansion of administrative power in only 10 years, all unintended.
But once the avalanche gets going it keeps going.
Unintended consequences
John H. Cochrane | The Grumpy Economist:
The Dec 14 Wall Street Journal amplifies my warnings on the movement to de-fund fossil fuels by financial regulation, citing “climate risks.”
“The Senate Democrats’ Special Committee on the Climate Crisis recently issued a report detailing how the Fed and eight other regulatory agencies should penalize investment in fossil fuels and promote green energy. They claim financial institutions are underpricing the risk that carbon-intensive assets will become “stranded.”
Mind you, their worry isn’t about how climate change per se would devalue investments, which financial institutions already account for. They want a warning about the costs of government climate policies.
“Because Congress has not advanced any comprehensive climate policies in the last decade, the market has not priced in the possibility of significant federal action,” the report notes.”
As reported this is at least a refreshing breath of honesty. In all I have read (not everything, it’s a mountain) of the BoE, ECB, BIS, OECD, IMF treatment of “climate risk,” there is a vague insinuation that climate itself poses a “risk,” which is utter nonsense.
Beyond nonsense, it is a directive for banks to make up numbers in order to justify de-funding politically unpopular fossil fuel projects.
(In case that’s not obvious, climate is not weather. The tails of the weather distribution and their minor effect on the profitability of large corporations are better known than just about any other risk, at horizons where bank supervision and risk management operate.)
Here, it is at least clear that the relevant “risk” is the risk that Congress or the administrative state will shut down businesses.
Actually, if taken seriously, honestly and generally, I might be all for it.
Yes!
Let our financial regulators require that firms and the banks who fund them disclose and account for all of the political risks that future government action might take to harm them – law, regulation, administrative decisions, and prosecution.
Indeed, state every possible nitwit regulation, idiotic tariff (Dec 29 WSJ is a masterpiece of how arbitrary administrative decisions make or break companies), or ridiculous law or politicized prosecution might harm the company or investment.
Let’s make this really tough – criminal penalties for failing to disclose ahead of time that, say, the government might challenge a decade-old merger, or decide with a secret algorithm that it doesn’t like the interest rates you charged or who you hired.
While we’re disclosing financial risks, let’s disclose the risk that a future Congress might remove the long list of subsidies and protections that your green projects live on. The long lists of well documented potential mischief would be edifying!
OK, I’ll stop dreaming. This isn’t serious, it isn’t about climate in any vaguely sensible cost-benefit way, it’s about fossil fuels.
It’s about de-funding fossil fuels before alternatives are available at scale, by capturing the regulatory system because the people’s elected legislators are not about to do it. (In the US.)
And it’s really clever. Or sneaky.
That the US Congress will take an action which strongly hurts the finances of fossil fuel companies is not a given. There are a few still who recognize, say, that fracking for natural gas has lowered US carbon emissions dramatically, and improved our economy and geopolitical situation.
A ban on fracking, or on nuclear power (Germany) would be a clear disaster. Will Congress really do it? Will the Department of Energy or the EPA really go so far on their own?
It’s not likely, is it. Banks and bondholders have taken a sober look at just how much damage Congress is likely actually to impose. They don’t think it’s likely to happen.
So the effort is clever: Try to get a financial run going ahead of time to avoid a risk that doesn’t exist.
The unintended consequences
The title of this post is “unintended consequences.” Here is the real question: How is it that the government has the power to force the financial system de-fund politically unpopular industries, under the guise that they might be “risky?”
Do we not have a nearly constitutional right to bet on an industry, be wrong, and lose a lot of money? When everyone else is shunning so-far legal fossil fuels fearing government action, do we not have a right to take the contrarian bet?
Well, no. And here is the really interesting story of a dramatic expansion of administrative power in only 10 years, all unintended. But once the avalanche gets going it keeps going.
It really goes back to 1933.
After that bank run, the US chose not to follow the “Chicago plan,” narrow deposit taking and equity-financed banking, and instead chose the path of deposit insurance, and bank asset risk regulation. With each crisis, we doubled down. 2008 was the most recent immense crisis, and basically a run.
Once again, we needed to fix one of two things: either financial institutions have to get their money by issuing equity and borrowing long-term in ways that cannot run, or an array of bureaucrats has to monitor how they invest their money, making sure they don’t take too much “risk.”
Our government doubled down on the second option. (Newcomers: A more detailed version of this little old lady who swallowed a spider history is in “toward a run-free financial system” and “a blueprint for effective financial reform.”)
And over the next 10 years the ambition of our regulators to regulate “risks” expanded dramatically. If they regulate only banks, financial activity moves outside the banking system, which it did.
So now the government “monitors” and regulates “risks” throughout the “financial system.” (Scare quotes indicate fuzzy words.) And the early restriction that risk had somehow to be “systemic,” threatening not an individual loss of money but a systemwide panic, faded away.
“Systemic” now means “anywhere in the system,” not “threatening a run to the entire system, not individual failures.”
At the cost of repetition, let me emphasize this point.
As I travel around and read the output of central banks and other institutions, in 10 short years it is now universally understood that regulators job is to “monitor risks” everywhere in the financial system. not just those risks that might conceivably cause a run, panic, or crisis.
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