Thursday, March 18, 2021

Testimony on financial regulation and climate change

Update: An expanded and improved version of this post is at city journal, or here (pdf on my webpage

I had the honor of testifying at the Senate Committee on Banking, Housing and Urban Affairs, on Protecting the Financial System from Risks Associated with Climate Change Full video at the link, I start at 48:30 with slightly abridged version of these remarks. 

Testimony of John H. Cochrane to US Senate Committee on Banking, Housing, and Urban Affairs 

Chairman Brown, Ranking Member Toomey and Members of the Committee: Thank you for the opportunity to testify today. 

I am John Cochrane. I am an economist, specializing in finance and monetary policy. My comments do not reflect the views of my employer or any institution with which I am affiliated. 

Climate change is an important challenge. But climate change poses no measurable risk to the financial system. This emperor has no  clothes. “Risk” means unforeseen events. We know exactly where the climate is going over the horizon that financial regulation can contemplate. Weather is risky, but even the biggest floods, hurricanes, and heat waves have essentially no impact on our financial system. 

Moreover, the financial system is only at risk when banks as a whole lose so much, and so suddenly, that they blow through their loan-loss reserves and capital, and a run on their short-term debt erupts. That climate may cause a sudden, unexpected and enormous economic effect, in the next decade, which could endanger the financial system, is an even more fantastic fantasy. 

Sure, we don’t know what will happen in 100 years. But banks did not fail in 2008 because they bet on radios not TV in the 1920s. Banks failed over mortgage investments made in 2006.  Trouble in 2100 will come from investments made in 2095. Financial regulation does not and cannot pretend to look past 5 years or so, and there is just no climate risk to the financial system at this horizon.

Sure, a switch to renewables might lower oil company profits. Oil stockholders may lose money. But “risk” to the “financial system” cannot mean that nobody ever loses any money! Tesla could not have been built if people could not take “risks.”  Yes, we are in a transition to a decarbonized economy, but the transitions from horses to cars, and from trains to planes, from typewriters to computers did not cause even blips in the financial system.  Companies and industries come and go all the time. 

So why is there a push for regulators to force financial firms to “disclose” absurdly fictitious “climate risks,” and change investments to avoid them?  These proposals aim simply to de-fund the fossil fuel industry before alternatives are in place, and to steer funds to fashionable but unprofitable investments and away from unfashionable ones, by regulatory subterfuge rather than above-board legislation or transparent environmental agency rule-making. This goal isn’t a secret. For example, The Network of Central Banks and Supervisors for Greening the Financial System (NGFS), which the Federal Reserve recently joined,   states plainly its goal is to “mobilize mainstream finance to support the transition toward a sustainable economy.”   

But financial regulators are not allowed to “mobilize” the financial system, to choose projects they like and de-fund those they disfavor. Thus regulators must pretend that they are dispassionately finding “risks” to the financial system, and oh, just happen to stumble on climate.  

The climate focus proves the dishonesty. There are plenty of genuine risks to the financial system that our regulators largely ignore. Imagine a new pandemic, one that kills 10% not less than 1%, and that lasts years with no vaccine. Suppose China invades Taiwan, or a nuclear weapon goes off in the Middle East. Another financial collapse can come. Imagine a global sovereign debt crisis. Suppose that the US Treasury runs out of room to borrow, is downgraded or defaults, and financial institutions no longer accept Treasury collateral. Imagine a massive cyberattack - all the accounts at Citibank are wiped out by North Korean hackers, and people rush for cash everywhere. These would indeed be financial system catastrophes.  Yet of all of these large, obvious and quite plausible risks, our financial regulators want to focus on just one, a fictitious climate “risk.” Why? Obviously, the end justifies the means. 

Some advocates are a bit more honest: They recognize there is no financial risk due to climate itself, but climate regulation could come along and “strand” assets or hurt companies. The Godfather would be proud: Nice business you’ve got there, it would be a shame if something should happen to it.  But think about it. This view posits that our environmental regulators are so bone-headed, so ignorant of basic cost-benefit analysis, that they might suddenly and dramatically not just wipe out industries and millions of jobs, but do it in a way that causes colossal bank failures like 2008. And if we go down this path, here too, why just climate-related risk? There is lots of political and regulatory risk. Regulate and disclose tech exposure, in case the FTC breaks up big companies. Regulate steel exposure, always on the edge of tariffs one way or another.   Uber could be outlawed by labor legislation tomorrow. An honest list of all the ways Congress or the agencies might plausibly destroy industries would make good reading.  But we’re not doing that, are we? The reason is obvious. 

Climate is really important. Climate is too important to let financial regulators play with it, inspired by what’s fashionable at Davos cocktail parties. Climate needs clear-headed, science-based, steady, and transparently-enacted policy, with explicit cost-benefit analysis. Underhandedly funding and defunding financial regulators’ momentary enthusiasms will repeat corn ethanol, switchgrass, an absurdly expensive rail line from Merced to Bakersfield that comes online just as all cars and trucks are electric, and other counterproductive feel-good policies. The US leads the world in carbon reduction today because of natural gas produced by fracking, which no regulator “mobilized.” Climate answers may include nuclear power, geoengineering, carbon capture and storage, hydrogen fuel cells, genetically engineered foods, zoning reform, a carbon tax, and other approaches, which financial regulators will never even envision let alone implement.

Financial regulation is really important. Financial regulation is too important to be eviscerated on the altar of de-funding fossil fuel and subsidies to pet projects. Once regulators cook up fantasy “climate risks,” the books remain cooked, and financial regulation loses whatever any ability to perceive and to offset genuine risks. Once financial regulators demand funding of today’s fashionable green projects, the political allocation of credit will expand. 

Financial regulation and the financial system are in peril, and not because of climate.  Contemplate the abject failure sitting in front of us. Despite 12 years of Dodd-Frank regulation, stress tests, and armies of embedded regulators, despite centuries of experience, ARS, H1N1, Ebola, Aids, 1918, and many federal pandemic plans, financial regulators failed to consider that a pandemic might come along.  We made it through the last year by one more massive bail-out, not by regulatory prescience. The financial system remains far too leveraged and far too reliant on an even larger bailout that may not come in the next crisis. And now they want to soothsay climate? 

We need to get financial regulation back to its job: making sure that run-prone financial institutions have adequate capital to withstand all sorts of shocks, which none of us, not least the regulators, can pretend to foresee.  It’s boring. You don’t get invited to Davos to talk about it. Industry hates being told to get more capital. But that’s its job and there is plenty to do.

Don’t let the EPA regulate banks, and don’t let our financial regulators dream up climate policy. You will get bad climate policy, and an even more fragile and sclerotic financial system if you do.


The following discussion was interesting. 

The confusion of climate with weather is pervasive. Many stories were told of weather events causing local damage. But as usual these are small on the scale of financial system trouble. Sen. Menendez, for example, brought up $4.5 billion of housing losses due to a hurricane in New Jersey. Well, I'm sorry for the losses, but that is a tiny amount in our financial system. No banks failed, no stock market crashed. Nobody stopped to think if the smartest way to reduce such losses is really to radically de-carbonize the economy and wait 100 years for hurricanes to get only slightly worse. 

The notion that it is regulators' job to stop anyone from ever losing money seems pervasive. 

It is interesting that so few can separate the need for climate policy from the need for financial regulators to step in. 

My fellow witness Ms. Waite offered a refreshing bit of clarity toward the end: She and others propose not to force disclosure of financial risks, but disclosure of total tons of C02. Given just how hard it is for a family to calculate its carbon footprint, disclosing, say, the carbon emissions of all of Chase's investments, properly apportioned (how do you split carbon between equity and debt) seems a.. tall order. But more deeply, that reveals the whole shell game: Use financial regulation to disclose carbon emissions, not financial climate risk. Why? Because there is no financial climate risk. 

Being briefly in the DC bubble is always interesting. I am interested how by simply repeating "climate risks" over and over again, people can talk themselves into a consensus so unhinged from obvious fact or basic quantification. 

In particular, it is astounding that so many state and restate a view that the climate may change suddenly and unpredictably in the next 10 years, with a sharp and large change in weather sufficient to cause immense damage to the US economy and provoke a financial panic. This would take 10% of GDP, more than any scientific forecast says happens in a century. It is pure fantasy. See the last question and answer though for this exact scenario repeated by supposedly serious people. 

Risk goes both ways. What happens if, say, carbon capture and storage works, nuclear/hydrongen breaks out, or even if the IPCC models turn out to be wrong? Windmills, electric cars, charging stations, and so forth turn in to horrible investments. If you're going to evaluate financial risk, you must evaluate that the current green enthusiasm might be a bit of a bubble as well. 

I found the whole business discouraging. My reading of the evidence is that climate change is real, an environmental threat more than an economic threat, and needs serious policy -- let's start with some even half-hearted cost/benefit analysis. The kind of obvious hogwash and hysteria offered here will inevitably lead to backlash, virtue- and political-affiliation signaling shows, and nothing productive will get done. 


  1. A lot of people seem to have trouble dissociating disagreements about means from disagreements about ends. I like free speech, but that doesn't mean I personally endorse what everyone do with it. I just don't want governments hunting people down for thought crime, nor do I want large businesses to collude to manipulate public discourse world wide. This isn't the same as agreeing with every disgusting antisemitic rant you can find on alternative social media platforms -- or among social justice circles on regular social media platforms, for that matter.

    The same dynamic happened to you here. "Oh. You disagree with our preferred policies?" gets quickly followed by a more or less polite version of "So what you're saying is you are a conspiracy theorist who disbelieve in climate change?" I'm half surprised the discussion did not devolve into an opportunity to call your views racist somehow. To some people, what they want and what the government should do is one and the same thing.

  2. "Biden’s ‘BackDoor’ Climate Plan--Emails reveal the strategy behind the new regulation to come." Wall Street Journal editorial in today's paper (3/18/2021) reveals the state of mind that has seized the Biden administration: The proposal is to have the EPA regulate ozone in order to drive hydrocarbon fuel use to zero. The editorial outlines how this will be effected.

  3. Made my day, you did. Good on you!

  4. Very interesting testimony. To what extent are we really completely certain about which places are most vulnerable and what the risks might be? Maybe we know about sea-level rise and where hurricanes hit, but there are a lot of unknowns. Just compare what people were writing 10 years ago to what we are experiencing now...

    I also agree about the distinction between climate change and weather risk, but isn't it true that we expect weather risks to worsen with climate change? If we have hypothetically have a large negative aggregate economic shock related to climate change, we would also expect that any weather event in that state of the world to be worse.

  5. "That climate may cause a sudden, unexpected and enormous economic effect, in the next decade, which could endanger the financial system, is an even more fantastic fantasy." Quite agree.

    I've been trying to get that point across to a variety of incompetent do-gooders writing for economic think tanks and similar for about a year now, and to little avail.

  6. Yeah, the Green New Deal will be off [Federal Government]budget!

  7. Agreed.

    By the way, you should also be frightened to death by domestic terrorism.

    1. I suggest that you should compare the risks of death, injury or financial loss from terrorism to the risks from other causes: road traffic incidents, street violence, fire, disease etc. before doing that. Don't judge your level of risk from just newspaper headlines. Having you succumb to irrational fear is the intention of terrorism.

  8. From your speech given for Mt Pelerin at the Hoover in January 2020; your blog 10/13/2020, "Understanding The Left," your testimony sees deeply into the strategy, tactics and objectives of the regulators and progressives.

  9. Strong af! But unfortunately, democracy is a corrupt power system. There is absolutely nothing to do against the dictatorship of the majority...

  10. If you read the Wall Street Journal today, your comments have had exactly zero impact. Thanks for making them. I can't imagine being in the office of economists at the SEC ("DERA") and having to put up with the crap flowing from the attorneys.

    1. the WSJ is a distant shadow of what it used to be

  11. The climate emergency clearly is a bubble. The interesting financial policy question is what the burst will bring? It is not (yet) big enough to bring a crisis, but the losses will be large. Who will bear them?

  12. As a Canadian financial advisor seeing a rapid rise in supposed climate related risk disclosure and ESG oriented products highlighting global warming as an existential risk, I thank you for making such a strong public statement.

  13. Re-posted this at Judith Curry's Climate Etc. If you don't go there, you might enjoy the latest blog on Climate adaptation sense. Part III: Dynamic Adaptation Policy Pathways.

  14. Cochrane: "Climate change is an important challenge. But climate change poses no measurable risk to the financial system."

    Sherrod Brown: "Today, the Banking and Housing Committee is holding its first-ever hearing on the risk climate change poses to our economy."

    Of course, the financial system is but one component of the economy. You could have a discussion about one that is distinct from the other.

    Did the hearing's title mischaracterize the intent and scope of the hearing? Did Brown alter the agenda after the hearing was scheduled and its agenda and title were set?

    In summary, in addressing the financial system vs the economy, it appears that the senator and the professor were--to some degree--at cross purposes here.

    1. U.S. Sen. Sherrod Brown (D-OH), Chairman of the U.S. Senate Committee on Banking, Housing, and Urban Affairs.

      John Cochrane's testimony was not off topic. Sen. Brown was purposely casting a wide net to up the visibility of the committee's remit.

  15. Great going prof. Cochrane.
    You should go to Washington more often and tell it the way it is.

  16. Good on you John for calling out this new fad by consensus. According to the Quincy Institute, US interventions in Western Asia have killed millions, dislocated 35 million people, destroyed economies, and infrastructure. Why not look at the carbon footprint of these pointless interventions, never won, badly defined, that have made up 80% of US interventions since the passing of the AUMF. This is what the cancellation of the AUMF now discussed in Congress might do for climate!

  17. Is it true that few of the climate change alarmists were calling for winterizing the gas lines instead of building more wind and solar generation? "Climate change" means colder colds in some places, as well as hotter hots, and this should mean money is spent to reduce the costs of such outlier events.


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