Could Cap and Trade Cause the Next Subprime Mortgage Scale Financial Crisis?

carbon trading subprime crash photo

Photo via First Strung

A new report from the Friends of the Earth says that cap and trade systems are dangerous. They allow traders to package emissions permits into complex financial products and sell them in bundles--much like they did with subprime mortgages. And we all know how that went. Though you may be surprised to hear this study emerge from a green group, which you'd think would be in favor of a system designed to reduce carbon emissions, remember that FoE, along with Greenpeace, actually publicly opposed the climate bill. They believed it contained too many giveaways to polluters, wasn't strong enough, and, well, that cap and trade wouldn't be effective enough. They're in favor of a carbon tax, and direct investment in cleaner infrastructure.

The Case Against Carbon Trading
In the new report, the FoE looks at the currently existing cap and trade systems, and the release says that the "trade in carbon permits and credits, mainly based in Europe, was worth $126 billion in 2008 and is predicted to balloon to $3.1 trillion by 2020 if a global carbon market takes off." Okay, it'll be a big market. So what's the problem?

The majority of the trade is carried out not between polluting industries and factories covered by carbon trading schemes, but by banks and investors who profit from speculation on the carbon markets - packaging carbon credits into increasingly complex financial products similar to the 'shadow finance' around sub-prime mortgages which triggered the recent economic crash.
The problem with this reasoning is, the responsibility of regulating financial markets should fall to financial regulators--this shouldn't be seen as a flaw of the cap and trade system itself. A carefully structured system should ideally be able to prevent abuses--though many people's faith in such regulators have rightfully been shaken.

Does Carbon Trading Even Work?
The FoE also claims that the carbon trading systems are failing to reduce emissions, while the traders who take advantage of it are getting rich off climate change--and will soon lose control as they did with subprimes. But the BBC reports that:

The allegation was instantly rejected by Patrick Birley from the European Climate Exchange, who accused Friends of the Earth of demonstrating a loose grasp of financial markets by relating carbon trading to complex sub-prime trading. "Carbon trading is a very simple trading tool much like trading in oil or gas," he said. He pointed out that carbon trading is merely a tool to achieve carbon caps set by governments.
And there's also the fact that it seems that the European cap and trade that FoE claims has failed is actually starting to work. Yes, the cap was a disaster at first, rewarding polluting companies with too a windfall of free pollution permits. But the system's operators learned from their mistakes, and have tightened permit rules, and the system shows signs of starting to work effectively.

The biggest problem with advocating scrapping the cap and going all in for a straight up carbon tax remains political infeasibility. The reasoning goes: it would be exceedingly difficult, especially in this economic climate, and especially in the United States, to sell voters on the idea of anything called a 'Carbon Tax.' Cap and trade may be far from perfect, but right now, it looks like our best bet.

More on Cap and Trade
Cap and Trade Won't Break the Bank: Climate Bill Would Actually Reduce the Deficit?
Obama's Cap and Trade Would Generate $645 Billion in "Climate Revenue"

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