The Biden administration believes that private companies and markets are not effectively pricing into their calculations the effects of man-made climate change on housing, stocks and bonds, physical assets, crop yields, and fire risks. Consequently, President Joe Biden has issued Executive Order 14030 on Climate-Related Financial Risk.
Pursuant to that executive order, Biden’s National Economic Council published A Roadmap to Build a Climate-Resilient Economy. The Roadmap is necessary, asserts the council, because “Wall Street financial models and investment portfolios that manage the assets of millions of Americans continue to rely on the basic assumption that climate will be stable.” The report outlines a “climate risk accountability framework” with the aim of “safeguarding the U.S. financial system against climate-related financial risk by holding financial institutions accountable for properly measuring, disclosing, managing, and mitigating climate-related financial risks.” That emphasis is in the original.
But are Wall Street and other investors blithely assuming a stable climate? Actually, no. There is plenty of evidence that portfolio managers, bond markets, businesses, farmers, and shareholders are taking the effects of climate change into account when planning their investments. On the other hand, government interference in markets is slowing financial and infrastructure adaptation to the risks of climate change.
For example, a March 2021 report on climate change and asset prices by researchers at the private investment firm Dimensional Fund Advisors outlines how various market actors are responding to the risks posed by climate change. That report cites a 2020 study that found that counties and municipalities with greater exposure to sea level rise must pay higher yields on their long term bonds. A 2019 study reported that houses exposed to sea level rise “sell for approximately 7% less than observably equivalent unexposed properties equidistant from the beach.” Another 2019 study parsing trends in the Chicago Mercantile Exchange weather futures contracts concluded, “the evidence shows that financial markets fully incorporate climate model projections.” The authors of that study added, “at least so far, climate models have been very accurate in predicting the average warming trend that’s been observed across the US. When money is on the line, it is hard to find parties willing to bet against the scientific consensus.”
The Dimensional report also references a 2019 Swiss Finance Institute study that found that since the 2015 adoption of the Paris Climate Change Agreement, banks around the world have been increasing the rates they charge fossil fuel companies for their loans. Their concern is that the transition to no-carbon energy supplies risks making the reserves of coal, natural gas, and petroleum worthless. “Overall, a growing body of evidence shows that prices across many different markets (stocks, bonds, climate futures, equity options, and real estate) incorporate information about climate risk,” conclude the Dimensional researchers.
The Biden Roadmap approves of moves at the Securities and Exchange Commission (SEC) to develop a mandatory disclosure rule for publicly traded companies that would supposedly “bring greater clarity to investors about the material risks and opportunities that climate change poses to their investments.” This SEC effort is mostly a following indicator since an increasing number of companies are already disclosing that sort of information. Earlier this year, Bloomberg Law reported that 342 of the companies in the S&P 500 mentioned greenhouse gases and climate change in their 2020 annual reports and 220 of them specifically addressed the risks that climate change poses to their businesses. Even the fossil fuel giant ExxonMobil began listing climate change as a risk factor to its businesses starting with its 2006 annual report. If investors and fund managers demand information, companies, however reluctantly, will supply it.
The Roadmap also observes that the risks stemming from hurricanes and wildfires are already disrupting the ability of local banks, insurance companies, and other institutions to serve particular communities. At the same time that private entities are adjusting their investment strategies to a changing climate, government programs are actually hindering the market signals that could spur people and businesses to adapt faster and more wisely to climate change. This is particularly true of government insurance programs like the National Flood Insurance Program (NFIP) and the Federal Crop Insurance Corporation.
The NFIP was conjured into existence by Congress in 1968 after private insurance companies had concluded that home and business owners simply would not pay the premiums needed to cover the losses of people who built on floodplains and along low lying coasts. The upshot is that the federal government has been subsidizing people to build, live, and work in areas subject to predictably dangerous and damaging flooding. Over the past 50 years, the NFIP has collected $60 billion in premiums, but has paid $96 billion in costs. In its new housing bill, the Democratic Congressional majority proposed in September to wipe away the $20.5 billion the NFIP borrowed from the U.S. Treasury to cover its losses.
The Biden Roadmap cites the recent implementation of the NFIP’s Risk Rating 2.0 that aims to achieve rates that are more actuarially sound and equitable while better reflecting and pricing a property’s flood risk. While raising flood insurance premiums is a step in the right direction, a study by the First Street Foundation earlier this year calculated that even after adopting Risk Rating 2.0, the NFIP would have to increase its rates by 4.5 times to cover the estimated flooding risk of the properties it insures in 2021. In other words, the federal government is still subsidizing people to build, live, and work in areas where the warming climate increases the risks of inland flooding, sea level rise and hurricane damage.
The Biden Roadmap also observes that climate change is increasing the risks to houses and people from ever more extensive wildfires. For example, an August 2020 study in Environmental Research Letters found that since 1979, a combination of rising temperatures and falling average precipitation has increased the likelihood of extreme autumn wildfire conditions across California. A recent study by the Milliman consultancy calculated that insurance companies lost a total of $20 billion in covering the losses from the devastating wildfires in 2017 and 2018 in California, twice the industry’s profits since 1991.
As wildfire risks have increased in California, private insurance companies have been seeking to raise their rates or drop coverage for especially risky properties. However, state regulators have banned them from doing so. The state has also stepped in with its Fair Access to Insurance Requirements Plan to provide bare bones fire insurance coverage when private insurers pull out. This is another example of how governments are encouraging people to ignore the rising risks associated with climate change.
The Roadmap suggests that increasingly severe heatwaves and droughts are already harming agricultural production. Heatwave intensity and duration in the contiguous United States has indeed been increasing over the past 50 years, but is still well below the hellish levels experienced in the 1930s. With respect to droughts in the lower 48 states, the last 50 years have been a bit wetter than the 120-year average.
On the other hand, in September a team of researchers at the National Oceanic and Atmospheric Administration issued a report analyzing the weather and climate factors behind the exceptionally intense drought now afflicting much of the Western United States. The report looks at regional trends in vapor pressure deficit (VPD), that is, a combination of temperature and humidity that specifies how much and fast moisture will evaporate into atmosphere from the land surface. As temperature increases, atmospheric demand of water increases exponentially. As such, higher VPD means the atmosphere can extract more water from the surface, drying it out.
The NOAA researchers find that normal weather fluctuations can only account for 50 percent of the record high VPD currently experienced in the Southwestern U.S. “This implies that human-caused warming played a significant role in the anomalously high VPD over the last 20 months,” concludes the report.
The Roadmap notes that the federal government will likely have to pay out billions more in crop insurance subsidies to American farmers each year by late-century due to the effects of climate change. Crop insurance protects farmers against losses from bad harvests and/or unexpectedly lower commodity prices. The crop insurance program is basically a subsidy in which farmers pay only about 40 percent of the premiums; it loses money every year.
Climate change has already increased federal crop insurance losses by $27 billion over the past 27 years according to a July 2021 study in Environmental Research Letters. On the brighter side, a 2019 study in Climatic Change projects that technological changes in U.S. agricultural production even in a worst case scenario will likely overcome the negative impacts of climate change on the yields of maize, soybeans, and winter wheat in America’s heartland.
The Roadmap does offer some useful directions to federal agencies with respect climate-proofing federal infrastructure and procuring climate-friendly products and technologies, but it is largely superfluous with respect to investors and businesses as they are already adapting to climate change well ahead of this exercise in federal guidance.