• January 31, 2023

Yellen Can’t Save the Polar Bears

The House Financial Services Committee will hold a hearing on Thursday on “Climate Change and Social Responsibility: Helping Company Boards and Investors Make Decision-Making for a Sustainable World”. This follows a number of initiatives by the Biden government to put climate change at the forefront of financial regulation. Treasury Secretary Janet Yellen has announced that her department will create a “climate center” with a “climate arena”. As Ms. Yellen noted at her confirmation hearing, the aim is to ensure that financial regulators “give serious thought to assessing the risk of climate change to the financial system”. This plan won’t do anything to save the planet, but it will certainly put a tax on borrowers and investors.

Ms. Yellen, Congress Democrats, and others seem to believe that financial regulators have a unique ability to influence the environment. Last week, Lael Brainard, a member of the Federal Reserve Board, delivered a speech entitled “The Role of Financial Institutions in Addressing the Challenges of Climate Change,” in which she said, “Robust risk management, scenario analysis and forward planning can help financial institutions resilient are climate-related risks and are well positioned to support the transition to a more sustainable economy. “Your point of view is as true as possible, but it would be just as true for any other problem that could be replaced by ‘climate related’. Proponents of financial solutions are nowhere near enough to explain how they would weigh the tradeoffs in their political approach.

Since the passage of the Dodd-Frank Act in 2010, US financial regulation has focused on predicting, measuring, and protecting against excessive risk to the financial system. For this very purpose, Dodd-Frank set up a new regulatory body, the Financial Stability Oversight Council. All of this was based on the idea that the Great Recession had led to intolerable taxpayer support for Wall Street that must never be repeated – hence the FSOC, which should prepare banks for appropriate disasters.

Unfortunately, the FSOC could not predict a global pandemic. With banks not having to mandate enough capital to support the financial system last year, regulators left open the need for a gradual, but ultimately much larger, rescue of American finances. Since last March, the Fed has been providing unlimited liquidity not only to banks but also to companies and even governments. This was complemented by Congress, whose lavish pandemic spending has added trillions of dollars to the national debt.

It’s not about blaming financial regulators for responding to the pandemic. This is to show that the usual policy toolkit is inadequate to prevent unpredictable future threats, especially those as uncertain as climate change.

The US financial regulators have no expertise in evaluating environmental laws and regulations. They do not employ climate researchers and have no better way to predict the effects of climate change on the financial system than to predict the weather. Michael Bloomberg’s task force on climate-related financial disclosures may be well-intentioned, but it is pure fantasy to believe that Wall Street can accurately model the market effects of climate change. Traders use the most complex modeling systems available, but markets keep falling. Predicting the future is difficult, and asking Wall Street to predict climate change and then asking financial regulators to develop guidelines based on those models is doomed to fail.

The difficulty of accurate modeling is not new to anyone. Which leads to suspicions that financial regulation against climate change is not intended to protect the financial system; They should influence who gets access to capital and who doesn’t.

Capital requirements are the main tool that financial regulators use to manage risk. If a bank’s lending is deemed risky, it must hold more reserve capital that is unprofitable on its books. Banks are also being discouraged from lending to borrowers who are not favored by regulators. Financial regulators could try to counter climate change by restricting lending to under-green industries.

The Obama administration set a similar policy limit on lending through Operation Choke Point in 2013, forcing banks to treat arms dealers, payday lenders, and other disadvantaged businesses as high risk to ensure they couldn’t get credit. Media reports of the operation sparked outrage, but perhaps not enough to prevent the same strategy from being revived to attack alleged enemies of the green economy.

Limiting the damage of climate change without mass poverty through higher energy costs is a serious task that is best left to economists and engineers. Financial regulators are not going to save the planet, but they can add to the cost of borrowers, which would be an effective tax on consumers. Climate activists would be better off encouraging investment in new technology. Our best hope is American innovation, rather than financial regulation.

Mr. Zerzan is a Washington attorney. From 2019 to 21 he was Deputy Principal Attorney in the Ministry of the Interior and from 2003 to 2005 Deputy Minister of Finance.

Journal Editorial Report: Paul Gigot interviews the economist Douglas Holtz-Eakin. Image: Stefani Reynolds-Pool / Getty Images

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