Powell passing the buck on climate
The US Federal Reserve board’s response to climate-related financial risk has both puzzled and frustrated not only climate change advocates, but also many of the Fed’s counterparts abroad, particularly at the European Central Bank (ECB) as well as members of Congress. Fed chair Jerome Powell’s July appearance before the House Financial Services Committee underscored just how out of touch the Fed is with the systemic significance and novel nature of climate risk.
In a troubling exchange with congressman Sean Casten, Powell agreed that climate change is a threat to financial stability, but only an “emerging threat… over time” and not yet a major concern for him. Powell made clear that Fed action to address contributions by banks to climate-related risk – including by advancing transition plans – is “not going to happen”.
Wait and see
Powell’s decision to wait and see just how damaging climate change will be for American families, financial institutions and the economy as a whole before the Fed acts suggests he believes that climate-related damage to the financial system can be repaired and climate-related risks can be mitigated, once their significance is obvious. However, this wait-and-see approach runs into a reality the Fed can’t escape: actions we are failing to take right now to reduce financed emissions will, given ecological tipping points, lock us into permanent significant change to our planet and financial system at an uncertain point in the future.
Powell further suggested that, to the extent climate risk is a concern, it’s a manageable one for the banks under the Fed’s supervision, since they “know their risks pretty well” and are adequately addressing them by “pulling back from lending in coastal areas and things like that”. On this point, Powell is sidelining findings of the Fed’s own pilot climate scenario analysis report that showed climate risks for large banks are “highly uncertain and challenging to measure” and banks themselves face significant data and modelling challenges in assessing their risks.
Powell is also ignoring the fact that, while large banks may have the capacity to manage or offload climate risks to other institutions, these risks remain in the financial system.
Climate change has the potential to make large portions of the country uninsurable, effectively ending mortgage underwriting in these areas, drying up housing markets and depressing real estate values.
When asked how he plans to address climate risk moving from lenders to government-sponsored enterprises (GSEs) – the quasi-government agencies responsible for enhancing the flow of credit for home mortgages and other sectors – as lenders offload climate risk-laden mortgages to these GSEs, Powell responded simply that the Fed doesn’t regulate those entities.
Ticking timebomb
But the Fed is responsible for maintaining financial stability and, at present, the flow of climate risk from insurers to banks, GSEs, reinsurers and investors constitutes a financial stability threat. The Fed itself has noted that it must “consider factors that can affect the stability of the entire financial system, including the interactions between firms and markets. In other words, the Federal Reserve’s supervision includes a macroprudential aspect that focuses on promoting overall financial stability”. As the Financial Stability Oversight Council (FSOC) – of which the Fed is a member – describes, “The increasing frequency and severity of extreme weather can affect the solvency of insurers and the cost and availability of coverage for homeowners and businesses… changes in the [property and casualty] insurance market could affect mortgage markets and house prices and could potentially generate larger economic spillover effects”.
Climate change has the potential to make large portions of the country uninsurable, effectively ending mortgage underwriting in these areas, drying up housing markets and depressing real estate values. As Casten observed, Americans hold approximately 30- 40% of their wealth in housing. The financial system and, more importantly, American families will suffer if a climate-driven insurance crisis takes an axe to real estate values and, in turn, local economies.
Powell may not be responsible for regulating GSEs or insurers directly, but the Fed will no doubt be tasked with picking up the pieces if a crisis in insurance markets spills over into the financial system and broader economy. The Fed was not responsible for regulating GSEs or insurers prior to 2008 either. But the benefit of hindsight makes clear that precautionary regulatory action would have prevented immense economic hardship and strengthened the financial system.
European regulators push ahead
When other central banks such as the ECB take action to mitigate climate risk, Powell insists they are acting only under a unique mandate to advance climate policy. However, the ECB’s Frank Elderson has confirmed that the ECB and other central banks are tackling climate risk as the significant financial stability risk it is, and not relying only on a special mandate to do so. Elderson has observed that “central banks and supervisors are not, and do not intend to be, policymakers in the area of climate and nature” while additionally noting that “central banks and supervisors have no option but to take the ongoing climate and nature crises into account to deliver on their monetary policy and banking supervision mandates”.
And European regulators are attempting to do just that: they are far ahead of their US counterparts in tackling climate risk, mandating transition plans and financed emissions disclosures, and integrating climate risk into the capital requirement framework. The ECB is poised to fine banks that have failed to make progress addressing climate risk, while the Fed has not even committed to assessing climate risk on an ongoing basis.
It’s only a matter of time before we all pay a much higher price for Powell’s inaction on climate-related financial risks.
Moreover, Powell does not apply his narrow perspective on the Fed’s mandate in a uniform manner. When the Covid-19 pandemic required swift, expansive and unprecedented action from the Fed, Powell responded in kind, innovating new tools to extend credit to businesses, municipalities, and nonprofits. Powell frequently touted the Fed’s “unprecedented speed and force” in responding to the pandemic and acknowledged that “the risks of policy intervention are still asymmetric”, with too little Fed action presenting more of a risk than too much.
Powell passes the buck
But when the crisis threatening American lives and livelihoods is climate change – a much less reversible threat – Powell is neither swift nor bold in his policy response. Instead he passes the buck to fiscal policymakers – Congress, the Treasury department and others. A call for fiscal policymakers to take a leading role mitigating climate risk is certainly appropriate, but this does not exempt the Fed entirely. Congress and the Treasury took a leading role in mitigating the economic harms caused by the pandemic, but the Fed assumed more than a spectator role.
“No one’s under the illusion that you’re the [Environmental Protection Agency],” Casten reminded Powell in their exchange, just as no one was under the illusion the Fed was the Centers for Disease Control and Prevention during the pandemic.
It’s only a matter of time before we all pay a much higher price for Powell’s inaction on climate-related financial risks. The significance, permanence and uncertainty associated with these risks should compel the Fed to act now. As Powell noted in the early days of the pandemic: “None of us has the luxury of choosing our challenges; fate and history provide them for us.” The climate crisis is more than a thorn in Powell’s side, it is the challenge of our generation and it is long past time for Powell to treat it as such.
