When he managed billions of dollars for Goldman Sachs Group Inc., Robert Litterman used sophisticated mathematical models to control risk. Now he is advising the government, and he believes it isn’t doing enough to avoid serious losses, including taking drastic steps to deal with the coronavirus pandemic.
In his work with federal regulators, Mr. Litterman’s main focus is climate change.
Mr. Litterman now chairs a group working on the risks of climate change for the Commodity Futures Trading Commission. In March, he testified before a congressional committee looking into the economic impact of global warming.
Mr. Litterman, who left Goldman a decade ago, told Congress that his analysis of the issue, partly based on models he used to manage risk in financial markets, shows failure to act quickly could result in a “tragic and potentially catastrophic mistake.” The way to offset that risk, he says, is to rapidly decrease emissions of carbon dioxide, a key greenhouse gas.
One way to curb fossil-fuel emissions, Mr. Litterman says, is through a carbon-tax. The Baker-Shultz legislative plan envisions a $40 per ton tax that would increase every year by roughly 5%. Money collected would be returned to U.S. citizens at a rate of $500 per person a year.
A goal of the tax—which Mr. Litterman thinks might be too low—is to affect incentives for consumers, business owners and investors, possibly changing their behavior.
He concedes, however, that the current economic downturn likely makes a tax on fossil fuels politically unpalatable for the time being.
The problem with many conventional models of climate change, including other carbon-tax proposals, is that they factor too much certainty into future outcomes, according to Mr. Litterman. Because of that, they don’t apply a high enough price on carbon right now.
Instead, the models should take into account periods of extreme volatility in global circumstances—just like the stock market has seen in recent months. The world needs to do the same with climate change, Mr. Litterman argues.
A twist in Mr. Litterman’s model is that over time, as the tax influences behavior and as new carbon-free technologies are implemented, the levy on carbon should decline. But the longer the world waits to curb emissions, the longer it’s going to take to tackle the problem—and the outcome is going to be much worse.
Creed Comments: Having a great financial mind like Mr. Litterman’s in the climate risk corner, gives significant credibility to the carbon tax cause. I believe we should “pay the public” a dividend to catalyze rapid decarbonization at scale.
Go deeper at https://carbon.substack.com/p/wizards-and-prophets-the-human-impact