Wednesday, October 15, 2008

Financial meltdown just a curtain-raiser to what we face with global warming

THE packages announced by the British, Americans and Europeans may be the circuit breaker that avoids the depression that would have come from the breakdown of the global financial system. But it is unlikely to avoid a recession as global credit continues to contract while banks get a handle on their balance sheets and the world learns to live on less.

So, at a time when investors are screaming for transparency, lessons from the hitherto-overlooked toxic assets that led to the Wall Street meltdown provide the opportunity to avoid an even bigger debacle, one with potentially greater economic consequences.

There is a disconcerting similarity between the responses to global warming and those to the dud assets created through subprime lending and financial innovation.

Both are examples of market failure. In both cases, banks, industries and regulators have ignored underlying risks that could devastate the global economy. The focus has been on short-term gains, where you pay the bare minimum now and pretend the day isn't coming when payment is due — or when fossil fuels run out. Where you pitch interest rate swaps, derivatives and layers of barely understood securities and then ask for a bail-out — or have urban planning that encourages more car use and freeways while paying lip service to sustainability.

At an investor summit at the United Nations early this year, Al Gore said the climate crisis was just another version of the meltdown. "The assumption that you can safely invest in assets that come from business models that assume carbon is free is an assumption that is about to go splat," he said. "You have lots of assets, many of you do, in your portfolios right now that truly do deserve that epithet: 'subprime'."

Like subprime assets, carbon assets keep many complex risks hidden from investors. Cost impacts from extreme weather events and legislation on greenhouse gases are expected to emerge as risk factors in pricing stocks and assigning credit and asset valuations. A warmer planet is joining capital and labour as the new resource constraint likely to alter production costs. And carbon emissions are also likely to increase the size of liabilities in key industries, from power plants to airlines.

Climate change will affect all parts of the financial services industry and all classes of investment. The global electricity market is worth trillions of dollars a year and energy is fundamental to economic growth. And, with $US6 trillion ($A8.5 trillion) in market capitalisation, the banks will play a critical role as they are the world's capital providers and the lead risk management experts.

But as with subprime, there are signs these risks are being ignored. Early this year, Ceres, the coalition of investors and environmental groups, and RiskMetrics conducted a study that evaluated the corporate governance practices of 40 of the world's biggest banks. It found that only nine mentioned climate change in regulatory filings, suggesting that most had yet to evaluate and disclose their material risks. Only 13 had developed specific climate-related policies. On a grading of one to 100 points, more than half scored below 50 points and the median score was 42.

"For a globe already faced with $US100-barrel oil and a projected 50% increase in energy demand over the next 25 years, climate change may bring the global economy to an historic tipping point," the report says. "While globalisation … (has) created wealth for a fast-growing human population, they have also hastened a day of reckoning when fossil fuel shortages and excess climate changing emissions could combine to spawn a global climate and energy crisis."

Writing in BusinessDay, Melbourne Business School's Joshua Gans said global agreement on climate change depended on management of the US economy; but, with the world's biggest economy now in recession, the chances of coming up with a deal for climate change have diminished. That's an alarming proposition given that 200 countries have only a year to go before a pact needs to be signed in Copenhagen replacing the Kyoto Protocol.

The reality is that when governments pump taxpayers' money into propping up banks, when central banks around the world offer unlimited dollars to ease the banking crisis and stave off a global recession, when Australia moves to guarantee all deposits for the next three years and all wholesale funding in international credit markets, reaching an agreement on carbon emissions loses its sense of urgency.

Indeed, there are many signs that reaching an accord has become less of a priority as the focus shifts to the economy. A Lowy Institute poll found that protecting jobs and boosting the economy had eclipsed global warming as the most important foreign policy threat. Similarly, the CleanTech index, which tracks 76 renewable energy stocks, fell over 18% in September, way more than the S&P/ASX 200 loss of 5.1%.

Still, CleanTech has outperformed the indices and one month does not a trend make. But the market meltdown and the loss of momentum on the climate crisis are linked.

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