U.S. Federal Reserve Board Chairman Jerome Powell speaks during a news conference following a meeting of the Federal Open Market Committee (FOMC) at Fed headquarters on September 21, 2022 in Washington, D.C. (Photo: Drew Angerer/Getty Images)

Wall Street Is Gambling With Our Future. The Federal Reserve Must Act Now

Leaving the clean energy transition to Wall street's voluntary actions is failing. The Federal Reserve needs to act swiftly, using its powerful regulatory tools to rein in banks' reckless fossil fuel financing.

Hurricane Ian, slated to be one of the costliest storms in history, torpedoed through Cuba, Florida, and South Carolina, leaving entire neighbourhoods underwater and millions without electricity. The damages in Florida alone were catastrophic, potentially costing up to $70 billion, grinding the local economy to a halt. After a summer of crushing heat, drought, and raging wildfires, it's clear that the physical impacts from climate change are mounting. By one estimate, climate change could cause up to $23 trillion in losses by 2050, far surpassing the 2008 financial crash. The climate crisis is pushing us into an era of profound economic instability.

Wall Street banks have time and again shied away from their climate commitments and are clearly afraid of accountability measures.

Yet, like with the subprime mortgage crisis, Wall Street continues to fan the flames, this time, by pouring billions of dollars every year into risky fossil fuels. Despite having made public "net-zero by 2050" commitments, in 2021 six US banks provided $63.9 billion in financing to companies that are rapidly expanding coal, oil and gas operations. This is disastrous for the long-term health of our economy and our planet.

If protecting our planet wasn't incentive enough to change course, the reckless financing of fossil fuels also exposes banks to transition risk. Fossil fuel assets will drop in value as we shift to a clean energy economy, which is quickly picking up pace with the passage of the Inflation Reduction Act and significant developments in clean energy technology. This means that banks with fossil assets on their balance sheets are now at even greater risk of a mass default on loans and those assets being stranded, which has the potential to cause another financial crash. The world's 60 largest banks are exposed to a shocking $1.35 trillion in fossil fuel assets. Unsurprisingly, most of the losses would be borne by ordinary people through their pensions, investment funds and share holdings.

These banks are hurtling our economy towards a climate-fuelled crash. Many of them recently threatened to leave Mark Carney's net-zero financial alliance over concerns of being sued for complying with tougher decarbonisation commitments. The legal threats are yet another instance of climate-denialism peddled by fossil fuel lobbyists and their political allies. But, seemingly in response to this threat, banks will now not be required to commit to the U.N.'s Race to Zero campaign. At this point it's as plain as day that leaving the clean energy transition up to voluntary private sector initiatives is failing. Unless the government steps up to rein in this reckless behaviour, the most vulnerable communities will bear a disproportionate cost for Wall Street's exploits.

There is one powerful banking regulator that has an important role to play in guarding against these risks and protecting the climate and ecosystem from Wall Street--the Federal Reserve, the U.S central bank. The Fed is tasked with maintaining a healthy economy, which includes regulating banks to keep the financial system stable. In a positive first step, the Fed recently announced that it will conduct climate scenario exercises--analysing the exposures of six large banks to climate risk next year--and that it will release climate-risk management principles as well. After lagging behind its international counterparts, these announcements indicate that the Fed is finally beginning to take climate risks seriously.

Now we must push for bolder action. Climate scenario analysis can be useful--depending on the kinds of scenarios used--to assess the risks to financial institutions. But it doesn't have any real teeth. It's merely an "exploratory" exercise at a time when we need the Fed to move from exploring to acting. Waiting for more data must not preclude ambitious action. We have enough information about the dangers of climate change to justify regulatory and supervisory action now.

So, the Fed must take a precautionary approach instead--rest assured, climate risks will materialise and we simply cannot quantify the precise nature and timing of these impacts as they are complex and ever changing.

To truly safeguard financial stability, the Fed must introduce policies that reflect the high risk of fossil fuel investment, like requiring banks to hold more capital against high-carbon assets. Higher capital requirements would disincentivize banks from investing in dirty fuels, and act as a buffer in the event that banks sustain unexpected losses, which is extremely likely given climate change. Eventually, the Fed must place outright limits on fossil fuel lending. These measures can help protect banks, the financial system and vulnerable communities from the impacts of climate change.

The Fed has been in the news a lot lately for raising interest rates in a misguided attempt to tame inflation by increasing the cost of borrowing and therefore dampening demand. Just last week we saw another rate hike. But this blunt tool will cause more pain and misery, and it won't tackle the root sources of current inflation, which include our overdependence on volatile fossil fuels, corporate profiteering and supply-side turmoil.

The volatility of fossil fuel prices contributes greatly to economic instability. Coupled with oil and gas companies price gouging ordinary people at the pump, it's clear that the best way forward is to ditch our addiction to fossil fuels. Instead of harmful rate hikes, the Fed could take a broader approach to its price stability mandate and help create the fiscal space for a just and green transition. Transitioning to renewable energy is a long-term solution that can help us build a stable and sustainable economy on a planet that will remain habitable for generations to come.

Wall Street banks have time and again shied away from their climate commitments and are clearly afraid of accountability measures. The climate crisis is not a theoretical risk, it is already having a profound impact on price and financial stability. The lessons learned from the Great Recession must now be applied to fossil fuel financing. The longer we wait, the greater the risk to our economy and our planet. The Fed has the authority and an obligation to act now.

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