Tuesday, March 3, 2009

Pushing for a green recovery requires also reducing the conflicting market signals.

Joseph Stiglitz and Nicholas Stern write “Providing a strong, stable carbon price is the single policy action that is likely to have the biggest effect in improving economic efficiency and tackling climate change”, The Financial Times “Obama’s chance to lead the green recovery”, March 3.

Although I come from an oil country, since it is always harder to bailout from a financial crisis than from a climate change crisis, I agree.

But these green market signals would be more effective were we capable of reducing some of the competing signals, for instance those present in one of the most important drivers of world capital namely the minimum capital requirements for the banks as defined by Basel.

Currently for a bank to make a 100 dollar loan to a corporation the banks currently need to have an equity that ranges from a minimum of 1.6 dollars to 12 dollars, a whooping 7.5 times the minimum, which depends on the risk assessments produced by the credit rating agencies.

Since bank equity is scarce, and expensive, especially now, this means that besides what the market would normally be charging for assuming a high perceived risk, the regulators have imposed an additional de-facto tax on risk. This would be great if “default risk of a corporation” was all that mattered. But what about the default risk of our planet? What if most investments in projects destined to fight the risk of climate change presented more risk than projects that increased the risk of climate change?

What if the securitized finance of car purchase financing gets an AAA rating while the project to install a solar panel only achieves a rate below BB-? Is it logical then that the financing of a solar panel needs 7.5 times more bank equity? I don’t think so!