David J. Phillip/AP Photo
Numerous risks from climate catastrophe would threaten the safety and soundness of banks and other financial institutions.
President Biden has prioritized the climate crisis early in his term, seeking to mitigate the worst effects of a warming planet and to stand up high-wage green industries that could rebuild an industrial base. But there’s a third priority related to climate mitigation: protecting financial stability.
As I wrote back in November 2019, numerous risks from climate catastrophe would threaten the safety and soundness of banks and other financial institutions. Natural disasters could overwhelm banks with mortgages on destroyed houses, insurance companies, and their interconnected counterparties. But there are also subtler transition risks from doing the necessary work of shifting out of fossil fuels and into cleaner sources of energy. This would leave financial firms and investors stuck with potentially trillions of dollars of worthless carbon-sensitive assets. This is essentially what happened in the subprime mortgage crisis, only instead of banks realizing too late that crappy housing loans were worthless, it would be oil and gas rigs and coal-fired power plants.
These risks must be managed carefully and well in advance, to prevent either climate disaster or a successful aversion of climate disaster from triggering a financial crisis. For decades, bank regulators in the U.S. have generally ignored this risk, putting us on a brutally dangerous economic course. But Treasury Secretary Janet Yellen, who was frankly part of this sloth while Federal Reserve chair, is finally putting in place a framework to prepare for the climate endgame, no matter what it brings.
Yellen will create a new senior position within Treasury to oversee a “climate hub,” to coordinate all departmental actions on climate. Reflecting the seriousness of the purpose, she is likely to task Sarah Bloom Raskin, a former colleague on the Federal Reserve Board of Governors as well as a former Treasury official, with running the operation. Raskin was seen as a candidate for Treasury secretary and comptroller of the currency, and someone with her high-powered credentials would raise the profile of the climate portfolio at Treasury.
That’s important, because the finance lobby, even before the announcement, is mobilizing to make sure they need not suffer any additional burdens or requirements from this office, and be allowed to go at their own pace on managing climate risk without government interference. This is quite literally a suicidal tendency, as it will be these same banks stuck with stranded fossil fuel investments as the transition to green energy ramps up.
The rumored choice to run this climate hub should have the big banks scared. Raskin was one of the most progressive members of the Obama administration, and has prioritized climate risk atop the concerns of financial markets. She wrote the foreword to an important letter from institutional investors last year, pleading with regulators to get serious about climate, and she has testified before Congress on climate risk as well. Last May, she excoriated the Federal Reserve for using CARES Act lending authority to prop up dying oil companies, precisely because fossil fuels are a disastrous long-term investment.
Many progressives have thrilled to the potential for Raskin in this position. “Financial institutions will play a key role in transitioning toward a 100 percent clean and renewable energy economy and Bloom Raskin is exactly the kind of leader for this national project,” said Alexandra Rojas of Justice Democrats and Varshini Prakash of Sunrise Movement in a joint statement.
The climate hub would coordinate Treasury actions on tax policy, as the U.S. seeks to eliminate fossil fuel subsidies and promote green alternatives. It would join with the Federal Reserve to head up international financial diplomacy; the Fed recently joined the Network for Greening the Financial System, a coalition of central banks. And it would lead the effort to foreground climate risk in bank supervision, as well as in systemic risk in the Financial Stability Oversight Council, which Treasury leads.
“It’s such an important first step,” said Gregg Gelzinis, former aide to Sen. Jack Reed (D-RI) on the Senate Banking Committee and now at the Center for American Progress. Gelzinis co-authored an issue brief last year on climate risk and financial stability. “You can’t accomplish the policy objectives in this space without building out the institutional commitment and capacity.”
The financial industry is perfectly content with climate transformation as long as there are no requirements placed on them to keep their promises.
It’s because the climate hub has so much potential power that financial players are getting out in front of it. The overriding fear from the industry is that Treasury will force climate risk stress tests, similar to tests that have already been introduced in the U.K., that would model adverse climate scenarios as well as financially hazardous green-economy scenarios, to see if banks can handle them. Non-climate stress tests have potential consequences including raised capital requirements, forced divestitures, and even total bank breakups. The industry wants to short-circuit that possibility for climate stress tests, claiming that the modeling is impossible, climate investments hard to price, and the regulatory burden simply too great.
Last October, before Democrats won back the White House, the Bank Policy Institute, a leading trade group, was already casting doubt on climate stress tests, calling them “extremely subjective and highly variable,” and asserting that they should only be used for “alerting regulators and banks” to climate risk, rather than pairing them with any consequences. You would need “significant further research and testing” to get to that stage, BPI claims. Sen. Pat Toomey (R-PA) recently questioned whether financial regulators have enough expertise to “make environmental policy.”
Of course, regulators wouldn’t be setting environmental policy, they would be preventing hazardous risks at the banks they regulate. “I think we should be prepared for banks to fight meaningful climate-related regulations at every step,” Gelzinis said. It’s notable that, this early in the game, banks are trying to stage-manage the conditions of the stress tests, rather than rejecting them outright. Gelzinis says there are methodological obstacles to designing climate stress tests, but they are not at all insurmountable. “Climate-related risks are on a much longer timeline,” he said, “but just because the risks materialize over 15 or 20 years doesn’t mean we can’t model them next to today’s balance sheets. We could see where the balance sheets have to shift.”
In other words, getting out in front of where bank investments need to go in the future would ensure a smooth transition, rather than a fire sale once fossil fuel assets lose their value. Stress tests are supposed to devise extreme yet plausible scenarios and game out how financial entities will manage them. They don’t have to predict the precise nature of climate risk at a point in the future. “We have to prepare for the climate Minsky moment, where the climate bubble bursts,” Gelzinis said. “That could happen in the very near term.” And without real actions to hold the banks to their stress test promises, it’s likely they won’t take them seriously, so tightened capital requirements or enhanced supervision must accompany a failed climate stress test.
Bank of America, Morgan Stanley, JPMorgan Chase, and others have made verbal commitments toward net-zero financing before 2050. But those commitments lack specifics, and in Bank of America’s case, it won’t promise to even disclose its fossil fuel assets until 2023. The financial industry is perfectly content with climate transformation as long as there are no requirements placed on them to keep their promises.
Press releases aren’t going to cut it when it comes to planetary survival. Treasury’s proposed action is a reasonable step to fighting the climate crisis, and Sarah Bloom Raskin a great standard-bearer for the effort. But the fight to truly green the financial system is ahead of us.
