Bond Buyer California Conference: Direct Lending, Pensions, 15c2-12, MCDC

Categories: Commentary, Uncategorized |

October 14, 2014

Last week, I attended the Bond Buyer’s California Public Finance Conference in San Diego and spoke on a panel focused on Climate Change (remarks excerpted below).   Hot topics at the conference were direct lending by banks, alternative financing from hedge funds, pensions, 15c2-12 and the MCDC initiative.

Also discussed were predictions for future supply next year and the long-term prospects of the bond insurance industry.  On the latter, Hector Negroni of Fundamental Advisors made an interesting observation, which challenges one of the insurance industry talking points:  “Insurance doesn’t increase liquidity, but rather changes distribution.”  His analogy of the municipal bond market to a “used car lot” was also amusing.

Prize for the most obscure buzzword goes to Mike’s fellow panelist, Tim Romer of Goldman Sachs.  In his remarks discussing the impact on infrastructure of climate change, Tim referred to “cross-sectional cascading infrastructure failures.”  This term refers to risk to our infrastructure caused by the interdependences of the various components and vulnerability to cascading failures.  For example, in the right circumstances, a power failure can quickly become a water or sewer issue.

While the mood at the conference was generally upbeat, the latest unemployment data clearly shows that portions of the State are still suffering.

California Unemployment Rate by County

(August 2014)


Source: DIVER Analytics-Map Module, Bureau of Labor Statistics

Gauging the Economic Impacts of Climate Change

The panel I spoke on was focused on climate change and my charge was to discuss the economic impacts.  Rather than reciting a litany of large doomsday dollar figures dramatizing the potential losses to California’s economy and to its cities, towns and counties from climate change, I elected to discuss some of the pitfalls in assessing potential economic impacts from climate change.

The recent drought in California has given us a window into some of the potential impacts from climate change.  The chart below highlights the exceptional water scarcity in California this year.

California Average Drought Intensity

(County Level Data)

10-14 2

Source: DIVER Analytics-Data Access Module, DIVER Data Solutions, and National Drought Mitigation Center

“Climate change” is an umbrella term that refers to a number of different potential developments, most frequently:

  • A gradual, but steady increase in average temperatures
  • More frequent bouts of extreme heat
  • Gradually rising sea levels and increased damage from storm surges
  • Generally more volatile and unpredictable weather

These changes translate into economic impacts:

  • Agricultural production is forced to change by making a particular area too hot to grow existing crops and by making inputs, like water, too scarce or expensive
  • Economies are hurt by higher temperatures, which can decrease labor productivity, and at extremes, create public health challenges. This could show up in agriculture, tourism, or even in housing markets as some places become less livable or attractive
  • Coastal property will be increasingly at risk from rising sea levels and higher storm surge, making some less attractive, and some potentially un-insurable
  • Regulatory responses will make carbon-intensive activities more expensive, prohibit them altogether

Perhaps one of the most difficult aspects of assessing climate change risk is the degree of uncertainty around predictions.  In a recent Bloomberg article, James Tormy used a phrase that stuck with me.  In discussing the work of a particular climate scientist, he referred to the: “…world of hyper-conditional climate change assessments.” As one thinks about risks and potential responses to climate change, it’s important to remember that predictions of future temperatures, water levels, or weather patterns are hyper-conditional.

A good example of this comes from a recent S&P report on the reinsurance industry.  In the report, S&P estimated potential industry losses from climate change and raised the possibility that reinsurers may be underestimating their exposure to climate change by a factor of 50%.  We can’t say which, if either, estimates are more accurate, but the difference of opinion highlights the difficulty of making these estimates.

The hyper-conditional nature of climate change predictions means that risk assessments should be based on a probability distribution of future potential outcomes, not on point estimates.

If you hear that temperatures are expected to rise by 7 degrees later in the century, realize that really means temperatures are most likely to rise by something between 5 and 9 degrees.

So climate change risk mitigation requires a cost benefit analysis of how much should be spent to address the most likely conditions, but also an assessment of how much tail risk one is willing to accept.

In calculating economic impacts, its also important to keep in mind that while one current activity may no be worthwhile after a change in climate, other activities may become more attractive and help to fill the gap and make up for some of the economic loss.

California has already seen examples of this in the agricultural sector via  “crop switching.”  Crop switching refers to the tendency of farmers to change what they produce in response to scarce, more expensive water.  Because water in California for agriculture was for a long time cheap and abundant, many farms grew commodity crops (like cotton, corn, wheat).  Over time as water has become scarcer and more expensive, some farms have switched to producing more high value crops (like almonds, pistachios, wine).  We have seen reports that the economics of growing even those high value crops does not work for some farms.  In these cases, the farmers have “crop switched” into the production of solar energy.

It is important to remember that when making economic impact assessments, the loss to the economy from one activity going away may be cushioned by the substitution of some new, more productive activity.

This week the Lumesis team is mostly local, with a few members going into New York City.

Have a great week,


Mike Craft
Managing Director, Credit, Lumesis, Inc.


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