By Bob Litterman
I’m a Wall Street risk manager. As an employee, a partner and, for four years, the risk manager at Goldman Sachs, I served many chairmen, including Bob Rubin, Hank Paulson and Lloyd Blankfein, who leads the firm today. Every one of them has always understood that managing risk is vital to the firm’s financial success and always a priority.
The same holds true for managing the risks of climate change. Unfortunately, too many of our leaders seem oblivious to basic principles of prudent risk management. The presence of uncertainty is no justification for inaction. In fact, the opposite is true.
In my business of investment banking, the risks we move to avoid are not nearly as threatening or potentially deadly as those posed by climate change, which has the potential to be a national and global catastrophe. But our policies aren’t reflecting the magnitude of that risk. Any professional risk manager who acted in such a way wouldn’t stay employed very long.
There are three important lessons from financial risk management that are key as we confront the challenge of climate change:
1. We have to pay attention to worst-case scenarios. That is what risk management is all about.
2. The issue is not minimizing risk; the issue is pricing risk appropriately.
3. A risk management problem is an urgent priority. Time is a scarce resource.
Republicans — and a good many Democrats — yearn for the economic stimulus that could be created by tax reform, including significant cuts in marginal rates. But with our skyrocketing national debt already dangerously high, it would be irresponsible to pass a bill that doesn’t recover the revenue lost by lowering rates. The best source — the second win — would be to price climate risk by putting a fee on carbon emissions.
Climate risk is directly in front of us today. Science has given the warning. We aren’t certain what will happen, but we know it could be catastrophic in terms of storms, flooding, droughts, sea-level rise and the loss of life and property. This is not an ease-on-the-brakes scenario; it’s time to slam on them. The only brake that will work at the scale required is the incentive that we now need to create, as a global society, to reduce greenhouse gas emissions.
Choosing not to price climate risk appropriately is insane. Every generation that follows ours will suffer if we do not brake in time. Think of it as a very serious bug in the global operating system.
We have a scarce resource: the atmosphere’s capacity to safely absorb emissions. We have no idea how much is left, if any, and, day after day, we are wasting this scarce resource. Even ExxonMobil’s new CEO agrees that we must fix this bug. Like bugs in computer code, this bug in the tax code can be fixed.
As our elected leaders head into negotiations on the tax code, the most intense debate is over how to pay for the cuts everyone wants. The House blueprint proposes to do that with a border adjustment tax (BAT) and elimination of the business interest deduction. Both are in serious doubt.
If, instead, we put a $40 per metric ton price on carbon emissions, we could generate $2 trillion over 10 years. Voters know climate change is real; they see it everywhere. Of course we all hope that the impact of climate change won’t be so bad, but hope is not a risk management strategy.
There is a unique opportunity today in the context of comprehensive tax reform to create appropriate incentives to reduce emissions. It is a perfect win-win opportunity for our elected leaders — stimulate the economy by lowering taxes and price climate risk. To waste this opportunity could be tragic beyond imagination.
Bob Litterman is a partner and chairman of the risk committee at Kepos Capital LP, a New York-based investment management firm. He is also on the Advisory Committee of the Partnership for Responsible Growth — advocates for pro-growth tax policy addressing the challenge of climate change with carbon-funded tax cuts.