Frankenstorm, the Not So Black Swan: Climate as the New Risk Variable
|Nov 13th, 2012 | Filed under: Alpha Strategies, Editorial, Today's Post | By: dfriedenberg||
by Doug Friedenberg
While waiting for the power to go out (which it did a couple of hours later) as we sat at home in Connecticut and Sandy approached, we read this comment by Elizabeth Kolbert in the New Yorker Blog:
“As with any particular “weather-related loss event,” it’s impossible to attribute Sandy to climate change. However, it is possible to say that the storm fits the general pattern in North America, and indeed around the world, toward more extreme weather, a pattern that, increasingly, can be attributed to climate change. Just a few weeks before the Munich Re report appeared, scientists at along the East Coast.” — “Watching Sandy, Ignoring Climate Change”, Elizabeth Kolbert, New Yorker blog.
Sandy has been one of a sequence of unusual weather events that have followed hard upon each other. And until Sandy, there seems to have been a cone of silence on the subject of climate change in the United States. This is noteworthy because climate change is discussed as a matter of concern in most of the countries on this planet, with one notable exception already referenced. Is this American exceptionalism? Or American denialism? Or are there other forces at work? And why should you care anyway?
Bernie Madoff, Climate Change Denial, and Talking Books
“It is difficult to get a man to understand something when his salary depends upon his not understanding it.”
- Upton Sinclair
If you’re a Republican, there’s a 75% chance that you disbelieve the scientific evidence behind the concerns about climate change. If you’re a Democrat, a 75% chance that you accept that evidence. Considering that the facts are out there in abundance, the discrepancy is, on the surface, mystifying. It’s more mystifying that there was NO discrepancy between party affiliation and view of climate science a mere fifteen years ago.
What happened? From Why We Resist the Truth About Climate Change by Clive Hamilton: “The opening of the gulf was due to the fact that Republican Party activists, in collaboration with fossil fuel interests and conservative think tanks, had successfully associated acceptance of global warming science with “liberal” views.” It is as if Republicans mostly decided that the Detroit Tigers won the just completed World Series, not the San Francisco Giants, because the New York Times, a noted liberal newspaper, reported that the Giants had won. Sound absurd?
There is a bit of cognitive dissonance in a country whose technological capability (which is, by coincidence, based on scientific research) is the most respected in the world, yet whose collective ability to grasp the implications of scientific research is negatively exceptional.
If you do happen to have Republican climate-change-denying tendencies and this is making you angry, chill. We could have quoted Mein Kampf, the part where Hitler talks about the use of propaganda and the reasons why truth has to be a casualty in maintaining total control of the people. Then you’d be really mad.
There is an increasing amount of evidence that the people who have bought into climate science denial were victims of a fraud perpetrated by a group of people pulling one of the oldest tricks on Wall Street: talking their book. Certain investors’ financial interests are adversely affected by the conclusions to which climate science points. The implications of climate science were easy enough to dismiss as long as real-time dislocations were minimal; most people can’t imagine the future until it washes over them. One could ask whether the attempt to manipulate climate science for personal gain is fair game in the Ayn Rand-ian world view, but we won’t.
A more benign view is that fossil fuel interests’ attempt to protect their financial position is akin to playing poker. Everyone at the table has the same objectives, and the attempt to “sell” your hand is an accepted part of the game. Poker is a zero-sum game. Whatever happens at the poker table affects only the other players at the table.
When the playing field is the planet, there are collateral (socialized) costs and benefits that result from the process of producing profits. The beneficiaries of many government programs, whether health, welfare, or even FEMA, do not generally pick up the costs, as is oft pointed out. Equally, the beneficiaries of tobacco sales have not generally had to pick up the socialized health costs that have been shown to result from tobacco sales, although they did have to deal with relatively marginal legal costs. And unless the economic interests benefiting from the climate science disinformation campaign have vacation homes on the coast in the northeastern United States, they are unlikely to bear any of the socialized costs, now about $50 billion, resulting from Hurricane Sandy. They may, in fact, benefit from short-term product dislocations.
One may question the degree to which responsibility attaches to those who may have intentionally distorted the public view of climate change. One may consider the asymmetric effect of neutralizing discourse in the global economic leader on a subject that affects future generations so profoundly. Eventually someone may try to quantify the socialized costs of the disinformation campaign, as solutions were stymied because of a concerted attempt to discredit the science.
Not to belabor the point, but there is an increasingly strong argument to be made that a chunk of the American population, some of it attached to gobs of money, has been fooled by the same sort of techniques that worked for Bernie Madoff: create a feel-good atmosphere decreasing motivation to look too closely at the facts, and encourage people to take comfort in the fact that some other wealthy guys believe it. Call it the Lead Investor Scam, if you will. Portfolio managers are mere mortals, we hear, and may occasionally be susceptible to letting others think for them. In principle, the investors who generate true alpha often march to a different drummer from the rest of the pack, and are used to taking positions that may cause social discomfort when they’re with their peers.
Clash of the Titans
“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.” –
If you told Exxon or Lukoil that, in order to avoid wrecking the climate, they couldn’t pump out their reserves, the value of their companies would plummet. John Fullerton, a former managing director at JP Morgan who now runs the Capital Institute, calculates that at today’s market value, those 2,795 gigatons of carbon emissions are worth about $27 trillion. Which is to say, if you paid attention to the scientists and kept 80 percent of it underground, you’d be writing off $20 trillion in assets.” Bill McKibben, Global Warming’s Terrifying New Math, Rolling Stone.
McKibben makes a critical point: investors harmed by climate change will rapidly become motivated to set the record straight on climate science once and for all. $20 trillion in assets seems like a lot, and you can understand why folks who control assets in that amount might be a tad defensive. But it’s not all that much, compared to real estate, for instance. The value of all real estate in New York City alone, a timely example, comes to about $850 billion. Current estimates of Sandy damage in the City are no less than $18 billion, with area costs currently estimated at up to $50 billion. A 2% hit to overall New York property values is one thing if it’s a one-time event; if there’s reason to believe that such a black swan event is turning grey or white, the game really changes.
As it happens, the estimated total value of real estate in the United States is currently about $19 trillion. And that real estate is subject to such weather events as the drought that currently is drying out about 50% of the United States. A quick review of desert land prices should help real estate investors focus on the problem.
The moment real estate investors around the world view their investments as being threatened by fossil fuel investors’ misrepresentations of climate science, Republicans who invest in real estate and Democrats will once again reach a consensus on the facts. If the oil guys live in drought areas, they might even come along too.
It’s a Brave New World. Isn’t That What You’re Paid to Recognize?
Financial markets discount the future. As financial markets begin to discount changes in the relative attractiveness of fossil fuel investments versus green investments, with real estate values being repriced to reflect climate effects, professional investors will get all the reality therapy they could ever need.
Financial markets also price risk. Insurance companies spend a lot of time evaluating the right price for certain risks. And the moment climate issues are no longer black swans, you can bet that they will reprice their insurance upwards to reflect their risk perception. And investors may have to reprice their waterfront assets as a result. There’s a two-week old press release from Munich Re that says, in part: “Nowhere in the world is the rising number of natural catastrophes more evident than in North America. The study shows a nearly quintupled number of weather-related loss events in North America for the past three decades, compared with an increase factor of 4 in Asia, 2.5 in Africa, 2 in Europe and 1.5 in South America. Anthropogenic climate change is believed to contribute to this trend, though it influences various perils in different ways. Climate change particularly affects formation of heat-waves, droughts, intense precipitation events, and in the long run most probably also tropical cyclone intensity. The view that weather extremes are becoming more frequent and intense in various regions due to global warming is in keeping with current scientific findings, as set out in the Fourth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC) as well as in the special report on weather extremes and disasters (SREX). Up to now, however, the increasing losses caused by weather related natural catastrophes have been primarily driven by socio-economic factors, such as population growth, urban sprawl and increasing wealth.” Don’t you just love it when insurance companies talk dirty?
Our suspicion is that we are now reaching the tipping point where people start to price their assets factoring in climate risks. Things don’t all have to be underwater for that to happen; it requires only for enough people to realize that it has become a risk greater than 0.05%, and that the risk is increasing.
Doug Friedenberg has a knack for taking esoteric financial topics and rendering them merely obscure. He is principal of www.jigsaw-capital.com, which arranges asset-based finance for small and mid-sized businesses.