Robert Litterman, a well-known economist —a “legend on Wall Street”— has an idea for spurring government and private investment into reducing carbon-dioxide emissions. Peter Coy, a New York Times columnist, discusses the “carbon-linked bond”:
“The problem Litterman is trying to solve is that many private investors are unwilling to invest heavily in climate solutions because they lack confidence that there will be a payoff. The government could promise that fossil fuels and other carbon sources will be very expensive in the future, making carbon-displacing technologies a safe bet. But governments are notorious for saying one thing and then doing another. They can’t be trusted.”
Well, he’s right about that. Now how would this bond work?
“The yield on the bond—i.e., how much interest it pays—is linked to the actual government-imposed price of carbon at any given time. ‘The government would announce a target carbon price, and if the government fails to hit that target, it will have to pay the bondholder more, so it has an incentive to keep its promises,’ Litterman wrote in an explainer.”
Where does the price come from?
This is tricky, but Litterman and an associated firm have come up with a “price of carbon” based on the variety of subsidies and regulations that the government has imposed. That is how much the government is de facto valuing the reduction of carbon dioxide emissions. If that number goes up, the country is succeeding in its quest to reduce emissions; if it goes down, it is failing, according to the theory. Thus a government bond whose return would depend on raising the price of carbon emissions would hold the government’s feet to the fire, Litterman indicates.
But why would a governmental entity (congressional or executive) ever agree to issuing such a bond?
Wall Street image by Kullez is licensed under Creative Commons license BY 2.0.