October 29, 2021
This piece appeared in American Banker:
The Financial Stability Oversight Council last week released its long-awaited report on mitigating climate risk in the financial sector. As expected, the report is yet another example of the Biden administration’s efforts to weaponize financial regulation to advance partisan, radical environmental goals.
Created after the 2008 financial crisis as part of the sweeping Dodd-Frank financial regulatory reforms, the FSOC brings together the heads of all the federal financial regulatory agencies, essentially forming a superregulator. The FSOC has a very clear mandate: to identify and mitigate systemic risk in the financial sector.
Systemic risk has a specific definition and is distinct from traditional business risk. Systemic risk, if left unchecked, can suddenly, without warning, bring down the financial system. Traditional business risk can be mitigated through the prudent risk management of banks, insurance companies and other financial sector participants.
The 2008 financial crisis is a good case study in true systemic risk. Poor underwriting standards in mortgages and declining asset prices, combined with complicated financial products tied to those mortgages in an interconnected financial system, caused the perfect storm and brought our financial system to the brink of collapse.
With this as context, would a reasonable observer view climate change as truly a systemic risk, analogous to the causes of the 2008 financial crisis? Could changing weather patterns, a process occurring over decades, cause our markets to suddenly seize up and bring down the financial system? I find that difficult to believe, yet that is precisely what this report suggests. At best, it is hyperbole. At worst, it is another disingenuous attempt by the Biden administration to leverage the financial regulatory system to advance extreme environmental policies under the guise of safety and soundness.
To be sure, there are financial impacts associated with extreme weather events. Increased frequency of flooding and wildfires pose risk to insured property. Banks must take risks of extreme weather into account when underwriting loans. The financial sector — banks, insurers, reinsurers — are managing that risk through enhanced underwriting standards, mitigation incentives or higher prices. But this hardly necessitates invoking the powers of America’s superregulator.
Among the FSOC’s authorities is its ability to designate nonbank financial companies as “systemically important financial institutions,” or SIFIs, essentially labeling those firms as too big to fail. Once designated, firms are subjected to enhanced oversight by federal regulators. This regulatory meat cleaver used to be the FSOC’s preferred tool.
To her credit, Treasury Secretary Janet Yellen has publicly stated that she intends to maintain the FSOC’s reliance on an activities-based approach. Unfortunately, she is getting pressure from the radical wing of the Democratic Party, including Sen. Elizabeth Warren, D-Mass., to revert to the FSOC’s “meat cleaver” approach. Congressional Democrats view the FSOC as an underutilized tool to impose burdensome regulations on the financial sector and possibly regulate out of existence industries they despise.
Last week’s climate report suggests Yellen may be giving into progressives’ calls to weaponize the FSOC. Among the recommendations are enhanced climate change disclosures by public and private companies; including climate change scenarios in regulators’ tests for how well banks can handle economic stress; and requiring companies to report their greenhouse gas emissions to name-and-shame firms and bias the market against fossil energy.
Late last year, I led more than three dozen of my Republican colleagues in drafting a letter to Federal Reserve Chairman Jay Powell, cautioning against the Fed injecting ill-defined climate change metrics into its supervision of the nation’s banks. Among other things, the letter raised methodological concerns with incorporating climate metrics into bank supervision, including the fact that climate change is a phenomenon that occurs over decades — a time horizon far beyond what it typically utilized for assessing banks’ ability to withstand stresses. Further, we stated that tying a bank’s performance on supervisory exams to ill-defined climate change metrics will ultimately cause them to decrease their lending to fossil energy companies, effectively starving an essential industry of much needed capital.
In his response, Powell stated that the Fed is not among the federal agencies charged with directly addressing climate risks and that the Fed does not dictate what lawful industries banks can and cannot serve. After reviewing last week’s climate report, it is clear the FSOC didn’t get that memo.
The report makes it evident that picking winners and losers and cutting off financing to the fossil energy industry is precisely the Biden administration’s goal. They realize they cannot pass the Green New Deal through a closely divided Congress, so they are searching for backdoor solutions to achieve that goal. They fail to realize that most Americans care more about energy affordability and reliability than illusory climate change goals. We are in the midst of a global energy crisis, yet the Biden administration is adamant about suffocating American fossil energy.
Financial regulators play an important role. They ensure safety and soundness in our financial system, protect investors and maintain liquid, orderly markets that facilitate access to capital for businesses of all sizes. Financial regulators are not climate scientists and should not be used as pawns for the radical environmental agenda.