The Fed risks a new financial crisis unless it does more on climate change

By David Arkush and Yevgeny Shrago

This op-ed was first published in Business Insider on September 9, 2021.

The climate crisis is creating risks that banks and regulators like the Federal Reserve are failing to address. Wildfires like the Caldor fire are destroying homes, neighborhoods, and entire towns. Hurricanes like Ida are battering and flooding our coasts. Weekly heat waves are overtaxing electric grids and buckling infrastructure. If we don’t get emissions under control quickly, extreme weather, drought, and migration will soon gut the economies of regions and nations.

A rapid transition to clean energy would create millions of jobs, improve public health, and reduce energy costs. But banks are still making massive investments in oil wells and gas pipelines, even though such investments will become worthless if we are to get emissions under control in time to avert catastrophe. If President Biden doesn’t nominate a Fed Chair and Board who will take an active role, the transition is likely to disrupt employment, retirement savings, and the entire economy.

A new Fed chair for a new mission

The 2008 financial crisis grew out of excessive risk taking by banks, coupled with a hands-off regulatory attitude. When it comes to the risk that climate change poses to the financial system, this is our 2007, when the risks of the subprime mortgage bubble grew into the causes of a financial crisis. Massive threats are on the horizon. Financial regulators need to act, or face a spectacular collapse. As President Biden considers the Fed Chair nomination, with a decision expected as soon as next week, he should account for where the Fed is on guiding the financial system through climate-related challenges.

Last year, the Fed finally joined other central banks in acknowledging that climate change poses a threat to the financial system. Since then, current Chair Jerome Powell has repeated that it’s early days on climate, and that the Fed won’t act before studying the issue more. His speech at the Fed’s annual Jackson Hole symposium, which he used as a de facto pitch for reappointment to a second term, didn’t even mention climate.

This approach invites disaster. To cushion the financial system from climate shocks that will dwarf the 2008 financial crisis, the Fed must act now. With a Chair who appreciates the threat, the regulator has the power to mitigate both the damage climate change does to the financial system, and the damage the financial system is doing to the planet.

The Fed is responsible for making sure the biggest banks don’t precipitate a new financial crisis. That includes JPMorgan Chase, Citibank, Bank of America, and Wells Fargo, the world’s four biggest funders of fossil fuels. Until the COVID-19 pandemic, megabanks had invested more in fossil fuels every year since the Paris Agreement, even as scientists and policy makers agree that fossil fuel expansion needs to stop for the world to avoid the worst harms of climate change.

That means these big banks are plowing money into investments that will become worthless as the clean-energy transition accelerates. It’s just the kind of dangerous investment that the Fed failed to prevent in 2007, opening the door to a financial crash that wrecked the economy.

Even worse, when these banks finance fossil fuels, they actively contribute to rising global temperatures. That means more climate damage. The banks are creating conditions that harm their business and the economy long-term, in pursuit of short-term profits.

Powell may get credit for forward thinking changes to the Fed’s monetary policy framework, but his approach to financial regulation is taking us back to 2007. Given the damage the 2008 crisis did to the economy, President Biden cannot accept that attitude in his nominee. The Federal Reserve could have stopped banks from selling bad subprime mortgage loans in 2007, and it can stop them from financing emissions that the economy cannot survive now.

Once the Fed Chair accepts this responsibility, they have the tools to bring banks into line. The Fed can make banks account for the riskiness of financing emissions and run stress tests that evaluate how climate change will threaten the financial system. To reduce risk, the Fed can make banks that invest heavily in fossil fuels hold more capital to protect investors, and even put direct limits on creating or holding the riskiest fossil-fuel assets.

Along with bank regulation, the Fed must review the monetary tools it employed during the pandemic. The Fed’s emergency lending during that panic was a bailout for fossil fuel companies. This bailout provides an ongoing implicit subsidy for these companies, lowering their borrowing costs. The Fed should instead put stringent conditions on any future lending and force investors to reckon with the true riskiness of fossil fuel investments.

Finally, the Fed must help cushion the economy from the impacts that are already baked in, which will disproportionately fall on low-income communities and communities of color. It must maintain its belated focus on full employment, making it easier for those displaced by the economic harms of climate change to find work. It should also help finance a just transition by deploying a stronger Community Reinvestment Act and show greater willingness to lend to state and local governments.

This is climate change’s eleventh hour. The Biden administration has acknowledged climate change as an urgent threat to the financial system. But in the absence of Congressional action, Powell seems determined to sit on his hands and let the financial system fund its own oblivion.

Biden must nominate a Chair and Board members who recognize the scale and urgency of the threat — and who will fulfill the Fed’s mission to protect the economy from climate-related threats using its full range of powers.