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A letter to Yellen

Summary:
Secretary of the Treasury, and ex Federal Reserve Chair Janet Yellen recently hosted an important meeting of the Financial Stability Oversight Council.  This is the highest level body overseeing financial regulation in the US. It matters. Her remarks start smoothly but critically, as one expects of a habitually well-prepared pro. A lot went wrong last year, ...

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Secretary of the Treasury, and ex Federal Reserve Chair Janet Yellen recently hosted an important meeting of the Financial Stability Oversight Council.  This is the highest level body overseeing financial regulation in the US. It matters. 

Her remarks start smoothly but critically, as one expects of a habitually well-prepared pro. A lot went wrong last year, from the treasury markets to another mutual fund bailout, and so forth. Bravo, it is time to get past celebrating how another bailout blowout saved the world and see if we can avoid another one. 

And then, 

We must also look ahead, at emerging risks. [To the financial system, the FSOC's purview Climate change is obviously the big one.

It is an existential threat to our environment, and it poses a tremendous risk to our country’s financial stability. We know that storms will hit us with more frequency, and more intensity. We know warming temperatures might disrupt food and water supplies, leading to unrest around the world. Our financial system must be prepared for the market and credit risks of these climate-related events. But it must also be prepared for the best-possible case scenario: that we begin a rapid transition to a net-zero carbon economy, which also creates potential challenges for financial institutions and markets. On all these fronts, the Council has an important role to play, helping to coordinate regulators’ collective efforts to improve the measurement and management of climate-related risks in the financial system.

Dear.. May I still call you Janet? I have known you for 40 years, since you were kind to a young brash graduate student. In all that time you have always worked for sensible well-reasoned, quantitatively evaluated policy. I don't always agree, but you always have clear, careful and conservative (in the move-carefully sense, not the political sense) thinking behind your recommendations. 

What the heck is going on? Surely you know this is nonsense? 

"Climate change is obviously the big one." The biggest risk? To the financial system? More than sovereign debt crisis, another run, another pandemic, war, revolution, pestilence, crop failure, another Great Depression, civil unrest, cyberattack ... I could go on. You have a much better imagination than that. So does your staff. 

Climate change "is an existential threat... poses a tremendous risk to our country’s financial stability." You don't really believe this oft-repeated trope do you? 

We do not, in fact "know" that storms will hit more frequently and more intensely. But even if they do, when was the last time a storm had more than a tiny effect on GDP, and threatened financial stability, a contagious run on the nation's debt-laden financial institutions? Weather has never, in all history, caused a financial panic. 

We do not, in fact "know" that slowly warming temperatures will "disrupt" food and water supplies. But even if they do, it is utterly absurd to imagine that you or your bank regulators can measure or control a causal chain from bank regulation to carbon emissions to warming temperature to food and water disruption to unrest around the world to financial stability (whew) which, let us remember, is the FSOC's only task. Do you really think that the most important way to prevent, say, a war in Syria in 2075 is for California to build a high speed train? This is beyond absurd. And even then, what does "unrest" abroad over food have to do with a coordinated US bank failure? Famines have come and gone, and Goldman Sachs remains unscathed. 

Why is the Janet Yellen I know and respect giving voice to such nonsense? 

I can tell you don't really believe it.  I note your choice to pass on tropes as they come rather than put your own views or analysis on them, cite sources, quantify effects, or speak as you always do when you believe something. I read you telegraphing that these are just empty words we all have to say now. But you don't. 

I know Washington is political, and a Treasury Secretary must go along with her President's agenda. But that does not mean you have to say such silly things in public. It will cost us all dearly, including yourself and the institutions you care about.  

How do financial institutions react when they hear the Treasury Secretary repeating such obvious balderdash?  They get the message: The FSOC is not looking for honesty, they're looking for political accommodation. Repeat the credo on climate, thereby signal your partisan support, and perhaps when we're discussing just why we bailed out your money market fund, the regulators will go easy on you. What other message could you expect regulated financial companies to get? 

When the American people, likely in two years, wake up to the fact that the institutions of government are spouting obvious nonsense, how will they react? Four years ago was a rebellion against the impression that the technocratic elite was incompetent. That impression is not allayed by these kinds of statements. That will hurt the important cause of climate.

It will also hurt the cause of financial regulation, which, as the first part of your remarks noted, we desperately need. Why should institutions pay any attention to your great thoughts on treasury market illiquidity, money market fund bailouts, and more, if the analytical thinking behind it can say in public that the way to stop civil unrest in the mideast in 50 years is to subsidize electric cars? 

You did not have to do it. You could have said, "The FSOC should study implementation of the Administration's executive orders on climate." You could even have said "The FSOC will continue to research the possibility of climate related risks to the financial system, " knowing full well what any honest quantitative research will find. You did not have to assert things that are so blatantly preposterous. 

Please, bring back sensible, fact-based, clear-thinking Janet Yellen. We need your gravitas, your steady hand on this ship. You don't have to join the woke putsch. 

***

(Note: Earlier comments on this issue here in an article at City Journal

Even if climate change somehow poses a risk to the financial system, surely it is a risk whose size, timing, location, and mechanism are impossible to monitor and guide from the top. So if anything it is one more argument for equity-financed banking. Just triple capital, reduce short-term debt financing, and the financial system can survive whatever happens. We know how to stop runs. It's not by monitoring fuzzy 50 year risks from the top. The regulators never noticed a pandemic might break out! ) 

 


John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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