by Richard Morrison
Chief Justice John Marshall’s observation, “[t]hat the power to tax involves the power to destroy,” has become part of American political lore. Marshall understood that the state’s revenue-extracting power can be weaponized—even against those who have committed no crime. We are now seeing a corollary to that notion in finance, with fossil fuel companies as the target. It turns out the government may not need to tax your company into oblivion if it can isolate you from all sources of commercial financing.
It has become an article of faith among climate activists that it is not enough for ethical investors to voluntarily divest themselves from hydrocarbon holdings. Governments and central banks must intervene in capital markets to eventually drive such companies out of business. This strategy is not new—previous generations of activists sought to restrict capital to firms that produce military hardware, nuclear power, cigarettes, firearms, and other politically disfavored products. But never before has government policy so forcefully been part of the plan.
In that spirit, the Senate Banking Committee held a hearing last year, titled “Protecting the Financial System from Risks Associated with Climate Change,” where members of the committee and witnesses were asked what the Federal Reserve was doing to save our planet from hydrocarbon-fueled climate disaster. One witness invited by the committee’s minority, however, had a different view. Economist John Cochrane of the Hoover Institution pushed back on the hearing’s premise that the federal government needs to be “protecting the financial system” from climate risks, suggesting that what climate policy advocates actually had in mind was to “steer funds to fashionable but unprofitable investments and away from unfashionable ones” via “regulatory subterfuge rather than above-board legislation or transparent environmental agency rule-making.”
Many policies favored by climate activists are out of line with prudent policymaking. Worse, they may arrogate entirely new powers to the agencies involved. In his congressional testimony, Cochrane pointed out that the Network of Central Banks and Supervisors for Greening the Financial System—which the Federal Reserve recently joined—has a stated goal to “mobilize mainstream finance to support the transition toward a sustainable economy.” But that is not how finance regulation works. Agencies like the Fed don’t get to pick the policy goals that their leadership happens to like, pressuring private parties to immanentize those outcomes. The Fed has a specific statutory mandate regarding unemployment and inflation—it does not have plenary authority over the entire U.S. economy.
Fortunately, more people are recognizing that the Fed is about to get dangerously out of its depth on climate policy. For instance, in November, Joshua Kleinfeld of Northwestern Pritzker School of Law and Christina Parajon Skinner of Wharton wrote in National Review of the effort to transform the Federal Reserve into a climate regulator: “It is democratically illegitimate for the Fed to engage in freelance activism. The Fed has no legal right to do so.” In a 2021 Vanderbilt Law Review article, Skinner pointed out that the allegedly pressing nature of a societal problem doesn’t magically expand the legal powers of a given government entity. She explained, “despite the substantive importance of climate change, the U.S. Federal Reserve presently has relatively limited legal authority to address that problem head-on,” concluding that “many aspects of climate change sit outside the Fed’s legal remit today.”
It would be a mistake in any case for the Federal Reserve Act to bestow on the Fed the expansive powers some think it needs to address climate change. The American Enterprise Institute’s Ben Zycher has discussed this in detail, emphasizing that the expertise one would need to do this prudently is entirely lacking at the Federal Reserve—and other agencies. Moreover, this problem could not be solved by convening a conference of professionals with doctorates in atmospheric physics. The uncertainties inherent in multi-decade climatological forecasts are not amenable to the supposed financial risk mitigation strategies that proponents want the Fed to employ.
Policymakers would be called on to make assumptions, not just about greenhouse gas levels or changes in the global energy mix, but also about detailed—and contested—scientific issues like the dynamics of cloud formation and regional climate oscillations. How will a given content of aerosols in the upper atmosphere combine with a La Niña event 20 years from now, to influence the value of corporate bonds sold to finance energy infrastructure five years ago? Will warmer winters and melting permafrost in Siberia threaten Citibank’s balance sheet? Will the greening effect of more carbon dioxide in the atmosphere benefit developing nations by helping increase food production? No one knows for sure, but banks are already being pressured to cancel loans based on the assumptions of a handful of non-expert regulators.
Advocates of climate finance regulation might retort that they don’t need to be sure about things like the average air temperature on Earth in 2100. We already face more immediate risks that will affect the economy and banks’ solvency. Therefore, regulatory institutions like the Federal Reserve should attempt to steer capital flows away from carbon-intensive investments to deal with those immediate risks. That’s true—but only because climate activists themselves have intentionally created and amplified those risks.
When the Securities and Exchange Commission (SEC) issued its first guidance on how public companies should disclose potential climate-related risks in 2010, it identified four sets of circumstances under which firms might be expected to have a disclosure requirement. They were 1) the impact of legislation and regulation, 2) the impact of treaties, 3) the “indirect consequences of regulation or business trends,” and 4) the physical impacts of climate change. In other words, any actual changes to weather patterns, sea levels, or natural disasters were an afterthought to the real financial threat to shareholders: government policy aimed at intentionally sabotaging hydrocarbon energy investments.
Thus, climate activists have managed to work both ends of the field. They publicly attack companies for being involved with oil and gas production, lobby for punitive policies to disadvantage those companies, and then turn around and label those efforts as a “climate risk” that corporations must disclose—and be further targeted by government policy. None of this has anything to do with climate change itself. No stakeholders are being saved from hurricanes or floods by any of this activity. It is a purely political attack on a legal industry that produces the vast majority of the energy that powers the United States and the world. Yet the proponents of this strategy claim that they are “protecting shareholder value” and reducing financial risks to investors. As my Competitive Enterprise Institute colleague Marlo Lewis recently wrote, the real point of all of this is not to identify banks’ climate risks but to intensify fossil fuel companies’ legal and political risks. It’s a self-fulfilling shell game.
This all leads observers to wonder which other industries will see similar attacks in the future. Just because climate change is the hottest topic in progressive policy circles today doesn’t mean that other issues won’t command similar attention in the future, as anti-nuclear and anti-firearms campaigns have in the past.
Unfortunately, we need not even make the case for a slippery slope; federal officials have already done exactly the same thing to other industries. In the mid-2010s, the Obama administration undertook a coordinated enforcement effort called “Operation Choke Point” to delegitimize and de-bank legal businesses that the administration had deemed politically incorrect, choking off their access to capital and financial services. Under the guise of protecting banks from the reputational risk of being associated with unsavory clients, federal officials warned banks that they should reconsider doing business with companies that offered everything from dating services and collectible coins to firearms and payday loans. Not surprisingly, many firms in such a heavily regulated industry took the hint and dropped those suddenly-controversial clients.
When the details of Operation Choke Point became widely known, it met widespread public blowback and was eventually discontinued. But the fact that senior officials within the Department of Justice, Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) all thought this was a reasonable approach to enforcement is alarming. It also raises the question: Why did they go about it in such a non-transparent way? If the businesses in question were so problematic, why not simply pass new laws that disciplined them for their alleged transgressions?
The answer, of course, is that any such public effort would have been unpopular and very unlikely to be approved by Congress. Most Americans don’t think that the small businesses targeted by Operation Choke Point should be exiled from polite society–but the progressive-left bureaucrats in the Obama administration did. Moreover, if Congress had decided to criminalize certain previously legal financial transactions, payday lenders and gun stores would have been entitled to due process in an Article III court. But that is not what the Choke Point architects wanted. They preferred a system of vague and unaccountable “regulatory dark matter,” whereby government lawyers threaten private parties with enforcement actions via guidance documents, letters, and blog posts. It is easier to pressure a regulated firm to cut off another business from services than it is to prove in a court of law that the business in question has actually done anything wrong. The effort to expel oil and gas producers from the financial system is following a similar playbook.
Finally, we must consider the long-term political impact of financial agencies like the Fed, SEC, FDIC, and OCC expanding their portfolios to include topics like climate change and risks like those targeted by Operation Choke Point. As University of Alabama law professor Julia Hill wrote in the Georgia Law Review in 2020, “because reputation risk is largely subjective, regulators can use it to further political agendas apart from bank safety and soundness.” That politicization, she goes on, “undermines faith in the regulatory system and correspondingly erodes trust in banks.” Brian Knight of the Mercatus Center has warned about turning financial agencies into “universal regulators,” noting that it is “dangerous for our system of government to have administrative agencies, rather than our elected representatives in Congress, setting policies to address important social problems.”
Leadership at these agencies can step back from the brink and confine their enforcement to the powers actually granted by Congress, but if they do not, a future Congress will need to nudge them back into their corners.
Furthermore, financial regulators’ freelance initiatives on social and environmental policy might not survive a federal court challenge. Consider a similar recent case of agency overreach. Last July, the Supreme Court struck down the Centers for Disease Control and Prevention’s (CDC) eviction moratorium, with the majority writing, “It strains credulity to believe that this statute grants the CDC the sweeping authority that it asserts,” and adding that, “If a federally imposed eviction moratorium is to continue, Congress must specifically authorize it.” Would-be climate finance czars might hear similar admonishments soon.