Bernard Hickey agrees with Henry Paulson that a carbon bubble is creating the same sort of financial risks built up in the credit bubble before the GFC

By Bernard Hickey

Everyone now understands that borrowing too much is a bad thing for any household or economy.

Borrowing and spending simply pulls forward consumption and if it borrowing rises faster than income then eventually the bubble of debt will burst.

That is exactly what happened in the US economy and the global financial system during the crisis of 2008 and 2009. American households consumed more than than earned for decades, using debt to bridge the gap.

Eventually they could not service the debt, triggering defaults that almost destroyed the global banking system in a cascading and ricocheting series of defaults, credit market freezes and bank collapses.

US Treasury Secretary Henry Paulson was the guy driving the ambulance at the bottom of the financial cliff in 2008 so he knows a thing or two about how imbalances build up in a system and how catastrophe can be unleashed by apparently small events.

Now Paulson has gone against the orthodoxy of his own Republican Party and called for concerted action to reduce carbon emissions and try to prevent a climate change catastrophe.

He has compared the credit bubble before 2008 with a carbon bubble now and he is very worried.

"Looking back at the dark days of the financial crisis in 2008, it is easy to see the similarities between the financial crisis and the climate challenge we now face," Paulson said this week.

"We are building up excesses (debt in 2008, greenhouse gas emissions that are trapping heat now)," he said.

"Our government policies are flawed (incentivizing us to borrow too much to finance homes then, and encouraging the overuse of carbon-based fuels now)."

Paulson, a former boss of Goldman Sachs, has cleverly turned a contentious political and scientific debate on its head.

He is saying climate change is as much a financial issue as an environmental one.

Quite correctly, he has addressed climate change as a financial risk management exercise, rather than purely a debate about science, politics and economics. Pointing to the potential for the melting of the West Antarctic ice sheet to melt and increase sea levels 4 metres, Paulson argued apparently small climate events could unleash big surprises.

"As we all witnessed during the financial crisis, a chain reaction of cascading failures ensued from one intertwined part of the system to the next," Paulson said.

"It’s easy to see a single part in motion. It’s not so easy to calculate the resulting domino effect. That sort of contagion nearly took down the global financial system," he said.

This week Paulson took the unthinkable step for a Republican of calling for a carbon tax. That puts him in the same camp as the Green Party in New Zealand.

Paulson argued that discouraging carbon emissions now may save massive public costs and fiscal deficits over decades as Governments are forced to pay to clean up after storms, repair damaged infrastructure and invest in ways to cope with rising sea levels, higher temperatures, droughts and many more severe storms.

The biggest companies all around the world are beginning to look at the issue of climate change and carbon emissions in the same way: as a long-term financial risk that has to be managed like any other.

Even oil giant Exxon Mobil was forced in April to acknowledge the financial risks of climate change, although it rejected suggestions from shareholder activists that its huge oil reserves may end up 'stranded' once regulators and politicians finally catch up with the science and act to reduce emissions.

Insurers have for years been calling for action and adjusting their catastrophe forecasting models for bigger and more damaging storms. Last year All Blacks sponsor and global insurer AIG issued a report calling on regulators, investors and credit raters to take climate risk into account when assessing insurers.

Corporations and Governments should now be building these risks into their own financial outlooks, which in turn should force voters and politicians to face up to the facts now determined by the likes of the Intergovernmental Panel on Climate Change.

For example, the Reserve Bank of New Zealand has just limited riskier mortgage lending to control the risks to the financial system from a potential bursting of a house price bubble.

Interestingly, the Reserve Bank is also the regulator of the insurance system.

How long before the Reserve Bank starts to build the risks from climate change into its assessments of the strength of insurers?

Should it, therefore, be making analysing and making recommendations about controlling carbon emissions in the same way it controls the riskiest lending?

These are the questions every business owner, banker, insurer, investor, regulator and credit rater should be asking.

This reassessment of climate change as a very real financial risk should jolt voters and politicians out of the vacuum that has sucked the life out of climate change policy debate for years.

Until now, politicians could easily point to the financial costs of carbon taxes as a reason not to take action.

Now it's the turn of the bankers and insurers and chief executives to tell politicians and voters about the financial costs and risks of not taking action.

Home owners and voters understand the concept of a housing bubble bursting. Paulson has rightly warned they should understand what a bursting of the carbon bubble would mean for their finances.

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A version of this article appears in the Herlad on Sunday. It is here with permission.