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?
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.
Read our 2017 paper on coastal real estate in the face of climate change risk.