The Next Financial Crisis Could Be Caused by Climate Change
Credit to Author: Geoff Dembicki| Date: Mon, 28 Jan 2019 13:48:39 +0000
There’s a psychological threshold you cross when a threat you dismissed as vague and abstract suddenly becomes real. An existential threat is distant until it is much too close to ignore, then impossible to stop. That’s what happened to California utility PG&E in mid-January. Fire investigators found that its power lines and transformers started at least 17 of the 21 major state fires of 2017, and potentially several more in 2018 that turned into massive wildfires because of hot and dry conditions worsened by a warming climate. PG&E suddenly faced liabilities of $30 billion and 750 lawsuits; investors freaked and the utility, formerly beloved by hedge funds, declared bankruptcy. Its market value plummeted from $25 billion to less than $4 billion.
“If you said just a few years ago that starting forest fires because of transmission malfunctions was going to bankrupt a major American utility, people would be like, ‘No that’s crazy, that can’t happen,’” Elias Hinckley, a Washington, DC–based energy and climate finance lawyer at the global law firm K&L Gates, told VICE. “But here we are.” The Wall Street Journal, whose opinion section has for years been accused of downplaying the planetary risks posed by climate change, reported that PG&E’s “bankruptcy could mark a business milestone: the first major corporate casualty of climate change.”
The question some people in the financial world are now asking is: Who will be next?
Once you go from understanding climate change as a distant future risk to a clear and present danger that can take down huge companies overnight, you see vulnerabilities everywhere. Here are a few of the potential outcomes: a hurricane that bankrupts the state of Florida, a housing foreclosure crisis caused by flooding in Texas, an economic meltdown brought on by the Colorado River going dry. In December, 415 investors put out a statement warning that unabated climate change could cause $23 trillion in global economic destruction over the next 80 years.
“That’s absolutely accurate,” Beau O’Sullivan, a spokesperson for the UK-based responsible investing advocacy group ShareAction, told VICE. “When this carbon bubble bursts we’ll see huge reverberations across our financial system, because climate change is a such a systemic risk that it touches every area of our lives.”
There were risk factors apart from climate change in PG&E’s financial implosion. California has always been prone to fires, and in recent years the communities that PG&E is required to provide electricity to have been pushing further and further into forested areas. The state also has an unusual law that can make companies liable for forest fire damages even if they aren’t directly negligent. But the crucial thing to note is that the legal and financial systems that PG&E put in place to navigate these dangers only worked up to a certain point. Those systems weren’t built to tolerate two years in a row of massive wildfires intensified by climate change.
“The systems [companies have] for managing risk can bend a little bit,” Michael Wara, a lawyer and research fellow at Stanford’s Woods Institute for the Environment, explained. “But they don’t sort of gradually evolve—what happens is they break, and that is what we’re observing in California right now.”
This principle could be applied virtually anywhere in the US. Yet it’s especially relevant to Florida. Since 1980, the state’s population has doubled to 20.7 million residents, many of whom live in coastal areas. And despite the risk of catastrophic floods and hurricanes, Miami is at the center of a real estate boom financed in part by overseas investors. None of this would be possible without a massive insurance market that (theoretically) insures homes worth a total of $2.1 trillion from disaster. Local insurers have in recent years been reselling insurance to buyers on Wall Street and around the world, drawing comparisons to the lending models that helped cause the 2008 crash. Additionally, the National Flood Insurance Program, a federally funded program that insures 1.7 million Florida households, is in close to $21 billion of debt.
“The state of Florida itself is heavily leveraged as insurer for much of the cost of extreme weather in the form of hurricanes and other tropical storms,” reads a paper from Florida storm risk expert Lorilee Medders. The hurricanes that batter Florida each year are getting stronger and longer, a phenomenon linked to climate change. The state’s system for managing risk works for now. But Wara thinks the wrong combination of factors—for example a Category 4 hurricane tearing into Miami along with a major storm surge—might cause major financial disruptions. “You could easily see the state of Florida go bankrupt,” he said.
You can also see the makings of a foreclosure crisis. As floods become more severe and frequent thanks to climate change, owners of damaged homes may no longer be able to afford insurance. One Houston homeowner’s premiums, for instance, went from $600 a year to $9,000 after Hurricane Harvey. And 80 percent of the 100,000 Houston-area homes that flooded during the 2017 disaster had no flood insurance at all, because they were in areas that don’t usually flood. Financial services firm CoreLogic has calculated that serious mortgage delinquencies for damaged homes shot up over 200 percent in the wake of the hurricane.
“It simply can’t be ignored anymore,” Ed Delgado, a former executive with Freddie Mac, a major home mortgage loan company, told CNBC earlier this month. “We’ve been given enough warning signs to take corrective action, and it’s about time you get proactive instead of waiting for these cataclysmic events to take place.”
Those warning signs could not be clearer for the 40 million people who rely on water from the Colorado River Basin. Despite near-constant drought conditions since 2000 and water levels at all-time lows, Arizona, Colorado, California, New Mexico, Utah, and Nevada have failed to negotiate a drought contingency plan, potentially leading the federal government to impose water restrictions by the end of January. If the river basin were to ever fully go dry, it could destroy 16 million jobs and $1.4 trillion worth of economic activity over the course of a year, a 2014 study from Arizona State University estimated. “Up until that point everything’s going to seem fine,” Wara predicted. “Then all of sudden it’s going to be an issue with enormous societal impacts.”
It’s important to note these are all hypothetical scenarios. None of them are guaranteed—or even necessarily likely—to happen. The point that events like PG&E’s bankruptcy drives home, however, is climate change is now testing the limits of society’s ability to manage and define financial risk. This has not yet appeared to sink in for the planet’s top risk assessors: insurance companies.
A recent survey of the world’s 80 largest insurers done by the Asset Owners Disclosure Project found only one-third “can say their approach to investing is climate-aware.” And 43 percent of the “laggards” named by the survey—that is, insurers with limited or no consideration of financial risks created by climate change—are based in the US, including such companies as Allstate, Prudential, and New York Life.
“They’re probably not taking these risks seriously enough because they see them as long-term,” said O’Sullivan from ShareAction, which manages the AODP. “They think they have more time, but they don’t.”
Observers warn that this confidence may be based on faulty assumptions similar to those that caused the financial world to be blindsided by PG&E’s collapse. “The potential for physical climate risks may change in non-linear ways, such as a coincidence of previous un-correlated events, resulting in unexpectedly high claims burdens,” observes a 2018 report from the International Association of Insurance Supervisors. “Uninsured losses arising from physical risks may have cascading impacts across the financial system, including on investment companies and banks.”
There appears to be a growing realization in some financial circles that time is quickly ticking down. In mid-January, a review of risks to the global economy put out by the World Economic Forum named “extreme weather” linked to climate change as the number-one threat. “Is the world sleepwalking into a crisis?” the report asked. Hinckley agrees the risk of enormous and long-lasting financial damage from climate change is real. “If you start to see enough pressure in the system,” he said, whether from climate-related calamities or a loss of investor confidence that comes with them. “At some point you slide past the place where your economy is growing to one where it’s retracting. We try to avoid that.”
Geoff Dembicki is the author of Are We Screwed? How a New Generation Is Fighting to Survive Climate Change. Follow him on Twitter.
This article originally appeared on VICE US.