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“Energy dominance” has to start with energy reliability.
Investors are betting on gas to meet the U.S.’s growing electricity demand. Turbine manufacturers, however, have other plans.
All American cities are at risk.
In 2025, it’s time for stern resolve and bold maneuvers.
Five years from the emergence of the disease, the world — and the climate — is still grappling with its effects.
It’s going to be worse than 2008.
Unpriced risk undermined the global economy during the financial crisis of 2008. Today, researchers say unpriced physical climate risk will lead to rapid declines in property values — and point out that this is already happening in some Florida markets. They often compare what’s happening now to the run-up to 2008. If the analogy holds, we will likely see disruption in other related financial structures. In particular, as the physical reality of climate change begins to have an effect on the attractiveness of bonds in risky areas, the ability of local governments to raise money to adapt to rapidly changing climate conditions may be undercut.
But comparing the effect of the 2008 unpriced risk on the municipal bond market with the potential effects of physical climate risk shows the suffering will likely be much greater this time. Today, there’s a direct, rather than indirect, connection between risk and public finance markets.
The solution? Last week, Tom Doe, CEO and founder of Municipal Market Analytics, said cities should act now to raise as much money as possible for adaptation before the municipal bond market starts pricing in physical climate risk. It’s only going to get more expensive later, in his view.
During the 2008 collapse, issuers of municipal bonds suffered. According to the final report on the crisis, New York State was stuck making suddenly skyrocketing interest payments to investors — the rate went from about 3.5% to more than 14% — on $4 billion of its debt. The Port Authority of New York and New Jersey’s interest rate went from 4.3% to 20% in a single week. Investors who had bought municipal bonds in auctions suffered too, because the pool of new buyers dried up very quickly in early 2008.
Since then, the muni market has bounced back in a big way, with professional investment managers urging tax-avoidant retail investors to buy individual bonds through separately managed accounts rather than through a mutual bond fund or an exchange-traded fund. Most people think $500 billion in bond issues is likely in 2025, and the group of buyers has a seemingly unending appetite for what they perceive to be safe and highly liquid investments — essentially the equivalent of money market accounts that promise federal tax-free interest payments.
But the risks now posed by physical climate change to municipal bond issuers and investors are different and likely greater than they were in 2008. The last time around, the municipal bond market suffered because of a domino effect — the insurance companies the issuers were using were exposed to mortgage risk.
According to the Financial Crisis Inquiry Report, so-called “monoline” insurers (writing policies for single financial structures rather than a broad array of products) had gotten into the mortgage-backed securities business, issuing a boatload of guarantees covering more than $250 billion of these structured products. The CEO of one of these monoline businesses, Alan Roseman of ACA, said, “We never expected losses. ... We were providing hedges on market volatility to institutional counterparties.” In other words, ACA believed its risk was limited because it wasn’t directly investing in the underlying assets — that its risk was limited to ups and downs in the market value of the mortgage-backed securities. But when the value of huge numbers of mortgage-backed securities plunged as the credit rating agencies woke up and repriced the risk of the subprime mortgages buried within them, ACA and other insurers were faced with stunning losses.
Those same insurers (MBIA, ACA, Ambac) were then substantially downgraded. And they hadn’t been insuring only mortgage-backed securities — they were also insuring municipal bonds and “auction rate securities” based on those bonds, structures that allowed local governments to borrow money at variable interest rates. When the insurance companies froze up because of the sudden repricing of mortgage-backed securities and their guarantees became worthless, the auction markets froze, as well. As a result, issuers of muni bonds (and investors in them) suffered.
In other words, in 2008, it was risk in a different financial arena — mortgage-backed securities guaranteed by insurance companies — that slopped over and caused problems for municipal bonds. By contrast, when it comes to physical climate change today, the municipal bond market is directly exposed to the central risk: Will the communities that effectively guarantee these bonds continue to be viable? Will these communities be insurable? Will community property values and thus property taxes suddenly decline?
Not only that, the 2008 risk was different because it could be eventually unwound. Property markets could get going again, as they have in spades. This time, deterioration of the underlying asset — the communities themselves — will likely be irreversible. Chronic flooding will not cease on any human-relevant time scale.
Issuers are not being penalized — yet — for the physical climate risk facing their communities, according to Tom Doe’s conversation with Will Compernolle on the latter’s Simply Put podcast last week. “This risk is not being priced in,” Doe said. “There’s no evidence of that right now. And in addition, the rating agencies have not reflected [physical risk] in their letter scoring of credit risk … so there is not a ratings penalty right now. There’s not a pricing penalty.”
Doe’s suggestion is that local governments may want to get out there and raise as much money as they can for adaptation. “State and local governments who are in harm’s way that need to do this can go to the market right now, and investors are not penalizing them. The market is not. So this is essentially cheap money if they issue [bonds] for these projects today,” Doe said.
That’s one way of looking at the situation. Public money for adaptation is cheap, there’s a lot of it potentially available, and it is much less expensive to raise that money now than it will be once the credit rating agencies and the investors start pricing in physical risk and demanding higher interest payments in exchange for the use of their cash.
It’s a race against time: Eventually, as in 2008, the mispriced risk will be correctly assessed. This time, unlike the last crisis, the harm to the underlying assets will be permanent.
A version of this article originally appeared in the author’s newsletter, Moving Day, and has been repurposed for Heatmap.
A cynical optimist’s take on the Inflation Reduction Act.
The optimistic case for the Inflation Reduction Act — even under a Trump presidency, even with a Republican trifecta in Washington — rests on a “public investment first” view of climate policy. Public investment in the clean energy economy is not merely a second-best policy option to carbon pricing or other punitive regulations, the argument goes, but instead the first-best option in the marathon of politically durable decarbonization.
I am an outspoken proponent of this view. Public investment provides and encourages investment to drive down the cost of clean energy technologies, make them more market-competitive, and thereby reduces emissions by permanently shifting demand away from fossil fuel-dependent ones. Public investment in clean energy technologies can also create the conditions for new constituencies to gain political clout and defend their role in the economy, and for further policy ambition in the future.
The first major sign that public investment under the IRA might prove durable came in August, when a group of 18 House Republicans wrote to Speaker Mike Johnson in support of the clean energy tax credits that are the cornerstone of the legislation, emphasizing the job creation benefits of the policy. Even the American Petroleum Institute and U.S. Chamber of Commerce said back in May that they would support the IRA under a Trump presidency. Driving down costs? Check. New constituencies? Check.
It’s tempting to see this glimmer of change in favor of clean energy incentives as the consequence of groundswell political support, as voters see benefits arrive in their communities. Journalist Kate Aronoff calls this “pool party politics," named after the New Deal’s high-visibility spending on public pools which curried popular favor in the 1930s. The IRA’s benefits do tilt heavily toward red districts, so it would be nice to imagine that Republican elected officials are hearing bottom-up support and dutifully reflecting constituent interest — democracy in action.
Let’s call that the optimist’s view. My view, which one might call the “cynical optimist’s,” is that politicians — red or blue — are often more responsive to the concentrated interests and influence of lobbyists and donors than the electorate. The IRA may have gained popularity in Congress, including among Republicans, as financial and corporate interests — “capital” — started becoming IRA fans. Tim Sahay of the Net Zero Policy Lab at Johns Hopkins has called the IRA’s tax credits a “bottomless mimosa bar” for the financial market, and bankers are swanning up to get smashed on unlimited tax incentives for clean energy investment.
I favor the cynical optimist’s view because I believe it to be a more accurate picture of why the IRA is good politics. The “cynical” part recognizes that capital exerts disproportionate influence over the political process; the “optimist” part celebrates that the IRA is a powerful vehicle to appeal to their economic values. Bottomless mimosa bars aren’t just booze giveaways — they work by bringing in new customers who then stay and pay for their meals. Reformulating the interests of capital through public investment is a pragmatic and necessary antidote to the inertia of the incumbent fossil fuel industry.
A great example of the IRA gaining new types of fans is its program of expanded, transferable clean energy tax credits. Not only do these tax credits redirect tax revenue toward clean energy investment, making more projects economically justifiable, they may also develop their own market momentum. I advise Basis Climate, a platform for clean energy tax credit transfers, and when I asked co-founder Erik Underwood to tell me who is actually buying these tax credits, he told me it has mostly been savvy business people focused on minimizing their tax payments. Many of these buyers have never or only marginally participated in renewable energy deployment previously.
The tax credit transfer market has grown to $20 billion to 25 billion in a mere 20 months. By comparison, voluntary carbon markets have for decades attempted to enable green projects by creating a market for tradeable credits, yet the market is expected to reach just $2 billionglobally in 2024.
In other words, the market for clean energy tax buyers has vastly expanded the base of corporates benefiting from and supporting clean energy projects, led by transactional people who want to avoid paying taxes. Now, there are tax-hating business types of all political colors, but one can already see that the politics of the IRA are shaping up differently than, say, a pollution tax that steadily gets harsher over time.
All that said, it is important not to overstate the case in favor of the IRA’s durability. Those 18 House Republicans are down to no more than 14 post-election, and the remainder may find that falling in line with the President politically safer were he to mount a full-scale attack on the IRA. They and corporate America may also love clean energy tax credits in the abstract but happily give them up to pay for a juicy tax cut for the wealthy.
Still, the most clearly durable part of the IRA are the $78 billion in public spending and whopping $493 billion in business and consumer energy investment that it has already catalyzed as of June 2024, an estimated 71% increase in private investment from the two years before the IRA. That investment won’t be undone with policy change, and it will radically change the economics of many clean energy technologies. It also lays the foundation for later policymaking, as distant as that possibility may now feel. By creating an expanded tent of clean economy interests, the “carrot” of public investment may also help future politicians and their constituencies find “stick” policies more feasible. Penalties on high-carbon products — from gas cars to steel — become much more palatable if they are merely driving substitution to other technologies that compete on price and quality, than if they’re just making the only serviceable option more expensive.
This more nuanced telling of the politics, though, means you don’t need a star-eyed, Mr. Smith Goes to Washington view of the American political process to see how the IRA is delivering political dividends. Whatever the fate of the IRA come January, the longer the benefits flow — to communities and to capitalists — the more difficult it will be to roll back the tide.
