Matthew Kahn raises the question at his blog Is Oakland “Inconsistent” as it Sues Fossil Fuel Companies While Downplaying Climate Risk in its Municipal Bond Prospectus? Excerpts below with my bolds.
Wall Street Journal: California localities warn of disaster when suing oil companies. So how come they don’t tell investors?
The WSJ has published a fascinating piece that points out an inconsistency in the expressed views of the leaders of Oakland’s city government. This coastal city is suing Exxon and other fossil fuel companies for engaging in business that threatens Oakland’s future (i.e fossil fuel burning causes sea level rise that will impose costs on Oakland). Oakland’s inconsistency occurs in the municipal bond market. Oakland seeks to borrow a large amount of $ by selling bonds. In the bond risk disclosures, climate change is played down. In this setting, Oakland has a strong incentive to state that it is a low risk because low risk borrowers can borrow at a lower interest rate.
The author of the WSJ asks a simple question; which truth does Oakland believe? Is it over-exaggerating the risk it faces to win the Exxon law suit while simultaneously downplaying a possible risk in the municipal bond market? Did Oakland’s officials anticipate that they could engage in such “mixed messaging”?
In truth, Oakland will need to borrow $ to help it engage in capital upgrades to prepare for sea level rise. The market will set the equilibrium interest rate to reflect the risk. If investors know that coastal cities have an incentive to lie and understate the true risk then new risk providers such as the nascent Jupiter project will emerge to provide this information. To put this simply, when you buy a used car — do you just ask the current owner for her assessment of its quality? Don’t be a sucker, do your homework.
The Exxon lawsuit raises major issues. I understand transaction costs but why aren’t the litigants suing gasoline car makers and gasoline car buyers? This lawsuit is an indirect court induced carbon tax. If the litigants succeed, what would be the economic incidence of this tax? Would Exxon’s profit decline? (More on the legal issues below)
A good debater might argue that the municipal bonds are issued for 30 years and over this time horizon, coastal cities do not face a serious challenge and thus the bond default risk is low. But, as you make these arguments think back in time. 1988 was 30 years ago. Technology has made some progress. By the year 2048, I have a feeling that our technological frontier will have leaped forward to help us to adapt to the new normal. The coastal capital stock will be less durable and we will be prepared.
Note: By the term “durable” in the last sentence, Kahn refers to the possibility of structures in vulnerable places being movable in the face of erosion or flooding. He and Devin Bunten discuss how developers are likely to adapt to localized climate risks in their paper Optimal Real Estate Capital Durability and Localized Climate Change Disaster Risk Devin Bunten and Matthew E. Kahn January 2017
(Board of Governors of the Federal Reserve System, University of Southern California and NBER)
The durability of the real estate capital stock could hinder climate change adaptation because past construction anchors the population in beautiful and productive but increasingly-risky coastal areas. However, coastal developers anticipate that their assets face increasing risk and this creates an incentive to seek adaptation strategies. This paper models climate change as a joint process of (1) increasingly destructive storms and (2) a risk of sea-level rise that submerges coastal property. We study how forward-looking developers and real estate investors respond to the new risks along a number of dimensions including their choices of location, capital durability, capital mobility (modular real estate), and maintenance of existing properties. The net effect of such investments is a more resilient urban population.
The above referenced WSJ article is paywalled, but this post by CEI gets at the securities fraud issue: SEC Should Investigate California Municipalities for Climate-Related Securities Fraud
It appears a variety of California municipalities have gotten themselves in hot water. To investors of their bonds, they have claimed that they are unable to predict sea level rise or other climate risks. But they recently filed suit against a variety of oil and gas companies claiming the companies are causing the sea level to rise. The municipalities in their lawsuits give very explicit predictions as to how much they think the sea level will rise.
Today CEI asked the Securities and Exchange Commission to investigate these activities as possible securities fraud. Federal law prohibits deceiving investors through untrue material facts or material omissions. The municipalities claim to the court that they are able to predict these sea level changes. If that is true, then they are deceiving investors. The SEC’s mission is to protect investors from such false statements.
A few examples of the conflicting statements:
- The City of San Francisco to bond investors: “The City is unable to predict whether sea-level rise or other impacts of climate change or flooding from a major storm will occur, when they may occur.” But to the court, the city predicts “0.3 to as much as 0.8 feet of additional sea level rise.”
- The City of Oakland to bond investors: “The City is unable to predict when seismic events, fires or other natural events, such as sea rise or other impacts of climate change or flooding from a major storm, could occur, when they may occur.” But to the court, the city predicts “66 inches of sea level rise.”
- The County of San Mateo to bond investors: “County is unable to predict whether sea-level rise or other impacts of climate change or flooding from a major storm will occur, when they may occur.” But to the court, the county states: “The County anticipates and is planning for significant sea level rise.”
- The County of Santa Cruz to bond investors states that “may be subject to unpredictable climatic conditions, such as flood.” But to the court, the county states that there is a “98% chance that the County experiences a devastating three-foot flood before the year 2050.”
There are two possible reasons why these municipalities have told the courts different statements than investors. First the municipalities may be trying to get more money from bonds then they would be able to get if they were honest about their true beliefs. For instance, the City of Oakland predicts the costs of “between $22 and $38 billion.” Would the city even be solvent trying to pay those costs? No investor would give their money to a city which expects not to be able to pay them back. If the municipalities were forced to explain what they claim are the expected impacts of climate change to their budget, they would no longer be able to raise as much money from bonds.
The second possible reason is that these municipalities are actually lying to the courts instead of investors by fabricating their predictions of sea level rise. Or perhaps they’re misrepresenting things to both investors and the courts.
Regardless, we hope the SEC can get to the bottom of this.
On the legal flaws with these lawsuits by cities: Is Global Warming A Public Nuisance?