28 January 2013

Who Thought That Bond Markets Might Address Climate Change Before Governments and Corporations?

Amita Sharma at KPBS did some fascinating reporting on how rising sea levels will impact a planned expansion of San Diego's convention center. She rather deftly turned climate change into an investment issue.

Maps generated by researcher Daniel Cayan at Scripps Institution of Oceanography and Richard Gersberg at SDSU suggest that by 2050, sea levels will rise between 18 inches to 4 feet along San Diego Bay, causing flooding in areas that include the convention center. Because of this, investment markets may curiously enough offer a way to begin addressing climate change, something that governments and corporations have been slow to do. This, from Sharma's report:

Commission planner Diana Lilly says she's aware of the maps and doesn't think they should be dismissed.
"We certainly are concerned about the issue of sea level rise and how it affects the convention center expansion," she said.
The market may also care. The $520 million project would be financed by bond investors. And they like to know when there are risks.
"In a securities offering you must disclose all material facts that could conceivably affect an investor in a transaction," said Gary Aguirre, a securities attorney in San Diego."Let me ask you would it affect an investor? Would it be valuable information to know the project for which the funds are being raised could be underwater before the bond was paid off? To ask the question is to answer it. Yes, that should be disclosed."

Per Aguirre's point, if you buy a bond that won't be paid back for 30 years, you'd like to know that the project you're funding will last at least 30 years. To invest in a project that might be forced to close after, say, 10 to 20 years is to lose money. As investors shy away from such projects, this could force communities to coordinate to arrive at solutions that address reality rather than deny it.

As odd at it may seem to some that the bond market - an engine of capitalism - may help to address climate change, it's worth remembering that bond markets helped to bring us democracy. Here's a section from my book, The Fourth Economy, that tells the story of how bond markets changed European governments in the early 19th century.

The King of Prussia Bows to Nathan Rothschild

Investors had a bad track record with absolute monarchs. Monarchs were too likely to spend money on unproductive causes (like huge palaces, for instance) and to default rather than submit themselves to moneylenders. Investors soon realized that parliamentary governments were more reliable than monarchs in terms of repayment. They therefore charged absolute monarchies higher interest rates. Often during the eighteenth century, Britain was able to borrow money at half the rate that investors demanded of the more frequently defaulting French.
In 1815, Napoleon was defeated at Waterloo and a king once again took the French throne.[1] Nonetheless, France had created an arms race among Europeans and unease among royalty, and this put a great strain on some of the more traditional economies, like those of Prussia and Russia. These countries were forced to seek financing for both modernization and armaments.
After the war, the Prussian king, Friedrich Wilhelm III, turned to the Rothschilds for a loan. Prussia was a great power. It was the country that would eventually bring about the union of Germany, and Prussia was home to the city of Berlin, which would become the German capital. The King of Prussia was no petty aristocrat when he came to Nathan Rothschild in the wake of the Napoleonic wars, asking for financing to modernize his country and army. Prussia was one of the great powers in Europe.
Yet Nathan Rothschild’s response to Wilhelm’s request for a loan was symbolic of the great shift in power that had occurred.  In a letter dated 1818, Nathan Rothschild explained to the Prussian King:
…the late investments by British subjects in the French funds have proceeded upon the general belief that in consequence of the representative system now established in that Country, the sanction of the Chamber to the national debt incurred by the Government affords a guarantee to the Public Creditor which could not be found in a Contract with any Sovereign uncontrolled in the exercise of the executive powers.[2]
Rothschild basically said that investors preferred parliaments to absolute monarchies, and he was defining terms for the loan in this initial negotiation, as any lender might do. What was highly unusual and completely remarkable was that a mere banker could dictate the terms of the loan to a king in this stage of negotiations. And these were not just any terms. He was requesting that Friedrich Wilhelm III submit to a parliamentary form of government in order to qualify for the loan he had requested. Through negotiations this clause was modified, but not by much. The finalized contract included a clause that basically demanded constitutional reform as a precondition for any further borrowing. This, perhaps more than any other act, signaled a watershed moment: a banker was now dictating terms to a king. Before the King of Prussia could borrow his next round of financing, he would have to share power with parliament. Just consider what this says about the rise of the banker in relation to the state. Nathan Rothschild, member of a group who in one generation could be forced off of the sidewalk by children, was now ordering one of Europe’s most powerful kings to give up power to Parliament. Step off the sidewalk indeed. The French armies wanted to topple kings and institute republics in their place. What the great General Napoleon was unable to do in Prussia with military force, Nathan Rothschild the banker was able to do with capital.

[1] Nathan Rothschild, who knew before other investors that Napoleon had been defeated at Waterloo, used information about Napoleon’s defeat to play the markets and to quickly make a small fortune, enlarging his capital and influence.
[2] Ferguson, The House of Rothschild, 270.

Investment markets force us to look forward. Right now, that future looks warm and soggy. Apparently, that's easier to ignore when we're talking about the abstract affect on future generations than when we're talking about the concrete affect on investment bonds we're selling today.

Amita Sharma's full report on how climate change is impacting plans for the convention center is here.

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