Climate change mitigation is creating a roadmap to a nationalized financial system

A Biden administration executive order issued in May required the Financial Stability Oversight Council (FSOC) and its member agencies to report on the risks that climate change pose for the financial sector and to recommend the measures needed to mitigate the purported risks. 

The October report garnered little press attention even though it represents the first step in the administration’s plan to use Dodd-Frank Act powers to effectively nationalize and thoroughly politicize the financial system. Existing statutes will be used to promulgate new financial regulations that will allow the administration to control the allocation of investment capital under the pretext of controlling financial sector systemic risk.   

The current fashion in climate change discussions within the financial sector distinguishes between two sources of climate change risk: extreme weather-related losses caused by physical damage and losses associated with transitional risk. Transitional risks are hypothetical losses that could materialize if governments and consumers alter their policies and demand patterns in response to new information about the immediacy of existential threats man-made greenhouse gas emissions pose to the climate and the environment.    

When it comes to weather-related events, those who believe that greenhouse gas emissions will inevitably lead to destructive global warming argue that higher temperatures will increase the frequency and severity of events like hurricanes, tornadoes, blizzards, droughts, floods, severe thunderstorms and hail. However, to date, there is little evidence that supports these predictions.   

According to Steven Koonin, President Barack Obama’s former Under Secretary for Science at the U.S. Department of Energy: 

“Over the last, roughly almost a century, we see no detectable trends in hurricanes. We do see for about the last 70 years some intensification of precipitation over the land…In terms of record-high temperatures in the U.S., they’re no more common today than they were 100 years ago. Yes, sea level rise globally has been accelerating for the last several decades, but it was also doing the same thing in the 1930s when, in fact, human influences were much smaller. So a lot of what we’re seeing can be put down to natural variability, or at least we need to show that it’s not natural variability… And the temperature has already gone up by a degree [since 1900]. So it remains to be seen.”   

Regulatory concerns about the importance of hypothetical weather-related financial sector losses are misguided. Banks and insurance companies have coped with losses caused by hurricanes, tornadoes, droughts and other extreme weather events for centuries.  

Evidence suggests that, on average, extreme weather events pose little risk to banks’ solvency. A recent Federal Reserve Bank of New York study finds that, over the past 25 years, banks adeptly managed extreme weather events through smart underwriting practices, geographic diversification, and the profits that arise from the increase in loan demand that inevitably follows the aftermath of weather-related disasters.   

Property and causality insurance companies are in the business of anticipating, pricing and mitigating losses associated with extreme weather-related events. Reinsurance markets exist to mitigate risks that cannot be managed internally. As a study by the Society of Actuaries documents, extreme weather-related losses have never endangered the solvency of a large insurer and insurance companies by nature are an unlikely source of systemic risk.   

The real paydirt for climate change doomsayers is transition risk. Transition risk is the risk that someday in the future, new information will convince government policymakers and consumers that the climate has reached “a tipping point” and that drastic steps must be enacted to reduce greenhouse gas emissions if humanity is to be saved from a global warming catastrophe. 

According to this scenario, governments will respond by enacting policies that prohibit activities that generate emissions to prevent “The Day After Tomorrow” from happening. Households and financial institutions will immediately try to sell any asset linked to emissions-generating activities causing massive ”fire sale” losses for households and financial institutions. The crisis will intensify as these losses cascade through the financial system.  

According to an article written by a senior official in the Biden administration’s Treasury, the agency in control of FSOC policy, such a rhetorical hypothetical scenario is sufficient cause to declare climate change transition a serious source of systemic risk for the financial sector. Moreover, under provisions of the Dodd-Frank Act, the official has written that such a conclusion gives the FSOC and its member institutions the power to anticipate and mitigate these risks with preemptive supervision and regulations that stymie speculative climate change transitional risks that may never materialize.  

The real goal is to control the allocation of capital in the financial system using the regulatory powers of FSOC members. The regulatory agencies will impose new rules that restrict financial institutions’ ability to fund greenhouse gas emission-intensive activities. They will require businesses to disclose government-approved measures of their greenhouse gas emissions and then take steps to discourage investments in business or consumer loans linked to high greenhouse gas emissions.   

New regulations would take the form of higher regulatory capital requirements for investments that fund firms with high greenhouse gas emissions; supervisory stress tests that incorporate extreme climate change transition shocks whose outcomes determine minimum regulatory capital requirements; elevated margin requirements and collateral haircuts for securities and derivatives tied to activities with high greenhouse gas emissions; limits on the total greenhouse gas emissions associated with an investment portfolio, and requirements that credit rating agencies downgrade securities linked with high greenhouse gas emissions.  

By using the systemic risk powers granted in the Dodd-Frank Act, unless they are stopped, agenda-driven financial regulators will modify the minimum regulatory standards that apply to investments made by banks, securities firms, insurance companies, mutual funds, private equity and other asset managers in ways that choke off funding to businesses that are allegedly endangering the financial system through their greenhouse gas emissions.  

If this is allowed to happen, not only will the price of energy and energy-consuming consumer goods increase dramatically, but our capitalist system, which allocates investment capital to its highest and most productive use, will be replaced by a system where unelected federal bureaucrats decide what investments and activities are funded.   

Paul H. Kupiec is a senior fellow at the American Enterprise Institute (AEI), where he studies systemic risk and the management and regulations of banks and financial markets.