Taps Coogan – January 12, 2022

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In yesterday’s testimony to the US Senate Committee on Banking, Jerome Powell confirmed that ‘Climate Change Stress Tests’ for banks are “very likely” and that they will be a “key tool” and top priority for regulators moving forward.

Explaining what that means, Mr. Powell, parroting the Bank for International Sentiments policy piece on ‘Climate Stress Tests,’ described two systemic risks from climate change.

The first risk is ‘physical risk,’ the notion that the banking or financial system might somehow be destroyed by a giant climate change induced natural disaster like a tsunami or hurricane. No, that is not a joke.

The second risk, and this is what it’s all about, it so called transitional risk. As Mr. Powell notes:

“The real risk would be transition risk and what that means is that some surprising event what have to take place that would destabilize the whole financial system and maybe caused a very large financial institution to fail in a disorderly way. How would that happen? It could conceivably happen through government policy…” 

The idea is to establish the premise that lending to someone in the fossil fuel industry is a systemic financial risk because they may someday be damaged by changes to government policy aimed at climate change.

The Fed now believes that it is therefore necessary to review all large banks and financial institutions to see how much they lend to ‘non-green’ industries and, potentially, apply stricter capital and regulatory requirements to the sinners.

By endorsing these stress tests, the Fed now accepts the notion that exposure to perfectly legal industries that do not otherwise pose systemic risks could nonetheless be systemically dangerous because of unknown future changes to government policy, political policy that they are forbidden by charter from prognosticating about.

Of course, once we establish that certain loans or financial products could be deemed systemically risky only because they involve industries that might be damaged by unforeseen future changes to government policy, there is no reason to stop with climate change. Why not review banks for lending into any industry that regulators could imagine being banned in some hypothetical future scenario to make sure that the level of exposure isn’t too high? Why not weapons manufacturers, or charter schools, or for profit prisons, or tobacco companies, or contractors that perform government services that you think should be banned? Maybe future Senators won’t like nuclear power? How about factory farming? How about Bitcoin? How about the cannabis industry, abortion providers, stem cell researchers, or censorious tech companies? The argument could easily be that we won’t know the risks until the Fed goes through every loan and tells us if it’s to a morally wholesome business that won’t someday be banned…

If I had to guess, and this is only a guess, Mr. Powell doesn’t actually want to go down this road and views it as a largely rhetorical concession to the left. If that’s true, he is a fool. By yielding to obviously partisan calls for ‘Climate Stress Tests’ Fed’s mandate has now been defacto expanded to include regulatory inquisitions for whatever the mob doesn’t like. Today that means climate change. Who knows what it will be tomorrow.

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