Digressions&Impressions

Climate Change: Central Bankers are Worried about Insurance

More frequent or severe extreme weather events and/or a late and abrupt transition to a low-carbon economy could have significant impacts on the financial system, with potential systemic consequences. Extreme weather events could lead to damage of physical assets, including real estate, productive capital and infrastructure, and loss of life with consequent property and casualty insurance losses, damage to balance sheets of households and firms, increases in defaults, and potential financial sector distress. A late and abrupt transition to a low-carbon economy could lead to a sudden repricing of climate-related risks and stranded assets, which could negatively impact the balance sheets of financial institutions....

Real estate and agriculture suggest themselves as sectors that are both particularly important and more immediately exposed to physical impacts of climate change, which could affect banks and insurers exposed to these sectors on both the asset and liability sides of their balance sheet. Furthermore, as physical risks rise or become more unpredictable, insurers will most likely increase premiums or stop insuring some risks. The implied decrease in coverage leads to increased uninsured losses (‘protection gap’) in case of a catastrophic event which could negatively impact the collateral value of properties, leaving banks exposed to credit risk. Understanding the trends in insurability, the cost of insurance, the protection gap, and their spillovers to the banking sector and the economy more broadly is an important direction of research. This requires an analysis of insurers’ role and behaviour, including the effectiveness of the catastrophic risk market. (p. 4)  "The Macroeconomic and Financial Stability Impacts of Climate Change Research Priorities," June 2020  NGFS: Central Banks and Supervisors Network for Greening the Financial System[HT Anne Kervers]

The "NGFS Technical document" quoted above is worth reading because, while it names no names, it is a forthright exploration of the limitations of existing scientific approaches to understanding the impact of climate change on the financial system and it contains several calls for more research in lots of areas that have become politically and morally salient. Here I am interested in using it as a granular, but useful window into what we may call the central bankers' consensus view about how to think about the significance of climate change to their jobs. So, before I get to insurance and reinsurance, let me just provide a two paragraph summary of that.

What is immediately noticeable is that the central bankers view their job as handling, that is anticipating and mitigating, the impact of "shocks" to the economy. And it is quite clear that they view the economy as a kind of autonomous system with a trendline, and their role is to mitigate and ameliorate the deviations to that trend line  caused by shocks external to the trend line. Behind the fancy language we can still discern the  idea that ordinary "fluctuations in economic activity are seen as the result of small, white noise shocks-impulses-that affect the economy through a complex dynamic propagation system," (127) and that major fluctuations have to be understood in terms of large demand or supply shocks.*

Crucially, in the central bankers' perspective, "demand shocks are typically manageable from a monetary policy perspective, [while] supply shocks are generally more challenging as they generate a trade-off for central banks between stabilising inflation and stabilising output fluctuations." (6)  The significance of climate change is viewed through the lense of a destabilising series of supply shocks that potentially overwhelm monetary policy. Strikingly, in the report this is viewed as a danger to the central banks' ability to fight inflation (6-9). Somehow, and this is remarkable in light of recent experience, the risks to deflation are apparently not worth noting at all.** 

There is, of course, plenty be said about the utility and normative significance of treating the economy in terms of deviations from a trendline, but let's turn to quoted passage(s). The first thing to notice is that the 2020 report highlights insurance and reinsurance. I noticed it before looking at last year's report, which is longer (and more detailed engagement with scientific literature); there insurance and reinsurance are entirely absent. Second, central bankers admit that from their perspective, at the moment, some of the best research on the effects of climate change on the economy is taking place in the insurance world, especially, I gather, integrating climate modelling with economic and geographic analysis. ("To this end macroeconomic modellers could borrow well-advanced methodologies used by (re-)insurance firms to quantify the economic impact of physical risks from extreme weather events, including spatial analysis.") I know nothing of this research, but will try to learn about it before long.

Third, the central bankers explicitly worry that in light of climate change insurance and reinsurance (henceforth when I use 'insurance'  and its cognates I mean both insurance and reinsurance) will become more expensive and, subsequently, cover less of economic activity. I think they are identifying a number of distinct concerns. And it may be useful to list them. [I] If insurers misjudge the underwriting risks because they are now in the realm of true uncertainty ["unpredictable"], they may go bankrupt. Since historical data are becoming less useful, underwriting is becoming more art than science reliant on the sensitivity to assumptions in complex modeling. If major insurers cannot pay out, or are perceived not to be able to pay out, then significant bits of the financial and real economy are exposed to serious damage [" financial sector distress."], if not collapse. Since AIG this is not just science fictions.

In fact, [II] the central bankers are worried about the future of insurance as a profitable enterprise ["longer-term climate change implications for the profitability/viability" (6)] What they do not say is that most risk modeling and portfolio management in finance presupposes that profitable insurance is possible. So, the significance of this concern is much wider.

[III] As premiums increase the central bankers assume that ordinary firms and individuals will be exposed to inflationary pressures and the decision to forego coverage. Strikingly the central bankers do not assume (a) that these will stop economic activity in the exposed areas; or (b) that governments will step in to provide insurance or to mandate/subsidize insurance. On (a) this means the central bankers assume that say due to path dependencies economic agents will persist in their activity without insurance and will tolerate considerable more uncertainty in their lives. And this will percolate through the system because a lack of insurance in one sector will impact its interactions with others. On (b) this strikes me as unrealistic. Governments will be lobbied extensively. Of course, at some point governments will have to make tough decisions about which parts of the economy to cover or not.

[IV] Central bankers are still very worried about bank balance sheets. Here the main concern is that the collateral that itself becomes worthless and is under-uninsured. It's one thing if the waves topple a hotel tower in Southern Florida and makes a loan non-performing; another if there is no insurance to pay back the principle of the underwriter. That leads to write-downs and deleveraging, etc. ["the collateral value of properties, leaving banks exposed to credit risk. Understanding the trends in insurability, the cost of insurance, the protection gap, and their spillovers to the banking sector and the economy more broadly "]

[V] The central bankers assume that the effects of climate change are not felt uniformly ["climate change could impact geographical/economic areas differently within a country or currency area." (7)] In particular, throughout the document they show awareness of the significance of  (what is known as) spatial economics; and that their existing models and policy instruments sit uneasily with a spatial or geographic approach to the financial system.

Finally, [VI] it is noticeable that whole areas of insurance that impact the vast majority of consumers and citizens directly (medical, car, travel, home-owner/renters, etc.) are either discussed obliquely or not mentioned at all. And while in many cases this will not matter much, it is important that somebody alerts the central bankers to the risks of cognitive capture by various industries. In the end they must be servants of the wider public, too. 

To sum up. Catastrophic risk insurance is a part of the financial system that generally is ignored by the public. Given the centrality of insurance in modern political economy, it is a good thing that central bankers are starting to reflect on what happens when agents start to wonder if they cannot count on insurance in a crisis.  The danger is, of course, this will very thought accelerates the possibility.

 

 

On Keeping School open; Middlebury, reconsidered (I)

Democracies and academies have, historically, risen together. Ancient Athens, where formal democracy first flowered, was also where, after the injustice of the execution of Socrates, Plato’s Academy and Aristotle’s Lyceum nonetheless bloomed. When the democracy succumbed to the geopolitical dominance of the Macedonian Alexander the Great, the cities’ new leaders shrank the size of the voting citizenry and once again sought the expulsion of philosophers.

In the young American republic, many in the founding generation recognized the importance of education to a democratic citizenry. The remarkable network of liberal arts colleges such as Middlebury, now scattered throughout the country and most densely in the Northeast, reflects that generation’s expectation that sacred groves of higher learning can improve and anchor a healthy democratic culture. Abraham Lincoln renewed that national commitment when he signed the 1862 Morrill Act, which gave us the land-grant public universities throughout the country.

But what does it take to preserve those sacred groves? How can colleges and universities meet their responsibility to nourish the intellectual life of a democracy generally? In a democracy, where freedom of association and speech are core rights and should be rigorously defended, the ethics of protesting should be defined by a commitment to embody in the protest itself the very norms that sustain democracies.

Democracies are necessarily contentious but can survive only if they can channel contestation into peaceful forms of behavior. Hence the importance of the first rule of protest — that it be nonviolent.

Second, protest on a college campus should have the goal of making a college the best it can be. The supreme academic aspiration is to defeat bad arguments with better ones. Rather than shouting down Murray, the protesters should have read his work and figured out how to critique it. There’s lots of room for that....Imagine how powerful a protest would be when one after another protester calmly and civilly puts a question to the speaker that reveals the holes in his argument.

Finally, to protect the sacred groves of academe, and the wellsprings of contentious but peaceful and intellectually rigorous debate in a democracy, those of us committed to the academy should step up to defend our campuses as places where two things are both true: Free speech is protected, and members of a campus community recognize their responsibility to prove themselves trustworthy to one another. Proving ourselves trustworthy means that it is wrong to fling insults and to swear at one another, even in cases where those things don’t add up to a legally prohibited threat or harassment. It also means that it is better to pursue argument with the other side than disdainful mockery of its views and to argue on the merits rather than make ad hominem attacks. This goes for both left and right.

Our civic culture is badly debilitated. Colleges and universities need to replenish their capacity to defend the intellectual life of democracies....At Middlebury last week, Murray and his hosts were also trying, simply, to keep school open. In this moment, they, too, were heroes.---Danielle Allen, Washington Post.

Danielle Allen taught the single most inspiring course I took as a PhD student. The course looked at funeral orations (Pericles, Plato, Lincoln) and has influenced these Digressions in innumerable ways. She has taught me to appreciate the significance of civic, patriotic rhetoric* and the ways in which sacred spaces can be carved out of otherwise mundane activities. I admire her scholarship and -- how partial are our affections -- we share a love of dogs. In addition, I have been pleased to see that in recent years she has established herself as a wise, public commentator.

Even so, it takes a bit of imagination and a shared willingness to indulge in useful fantasy to treat the alcohol and drug fueled club med, party atmosphere to be found "at the remarkable network of liberal arts colleges...now scattered throughout the country and most densely in the Northeast" as sacred groves (unless one is thinking of Orphic mysteries). A reformation of our badly debilitated civic culture cannot be founded on such quicksand. If one of the tasks of "colleges and universities" is to defend the intellectual life of democracies, it will require sturdier reflections than the ones offered by Prof. Allen in the Washington Post.

Before I address Allen's underlying arguments and vision, two important preliminary remarks.

1. I condemn the violence directed at professor Allison Stanger. I warmly recommend anybody to read her chilling account of what she experienced. (I would have also condemned violence directed at others at this event!)
2. The analogy between the Little Rock Nine and Murray that Allen deploys is based on flawed analogical reasoning. While both involve mob threats, the Little Rock nine were manifestly innocent and being discriminated against with the power of state government arrayed against them; none of these characterizations apply to Murray. All mobs are bad, but they are not bad in the same way.  In what follows I do not mention the Little Rock Nine again.

In her piece, Allen attributes four not entirely complementary functions to universities:

1. they have a "responsibility to nourish the intellectual life of a democracy;"
2. to "improve and anchor a healthy democratic culture;"
3. to "defeat bad arguments with better ones;" 
4. to "defend the intellectual life of democracies."

In what follows, I assume charitably, and for the sake of argument, that Allen does not think this list exhaustive (given that other important functions are absent: research, imparting knowledge, and teaching various skills and, perhaps, virtues are so evidently absent in her piece.) It looks as if she thinks that defeating bad arguments with better ones is the means by which the intellectual life of democracies is defended, improved, and nourished (etc.). Now, as a trained analytical philosopher this pleases my vanity because it makes my guild the intellectual guardians of democracy.

Even if we take Allen's position at face value it presupposes that the better arguments will turn out to support democracy and its intellectual life. That is to be wished, but by no means self evident. Even if the better arguments support ideal democracy, it is by no means obvious they support our present imperfect democracy.

The previous paragraph matters because if we assume that universities will simply deliver the politically right results we will be delusional about what might happen. As I suggested yesterday, our current crisis in liberal democracy is, in part, a failure of liberal education. Moments of crisis ought to encourage us to rethink the nature and content of higher education. Professor Allen supplies the natural example of this in her argument (but misunderstands it here); the Morril act of 1862 (in the midst of the civil war!), was part of Lincoln's larger redefinition of the nature of the American state and the nature of its aims and obligations not the least the role of higher education in it. (See also my two most recent pieces on Lincoln, here, and here, and my older one here.)

A focus on argument is also a rather reductive interpretation of intellectual life. There are many other skills (e.g., ability to deploy analogical reasoning, decoding of cultural meaning, an ability to scrutinize one's own tacit assumptions, ability to read and convey complex texts, the ability to distinguish propaganda from, say, civic religion, etc.) that matter to it in a democracy. To be sure, skill at applying an argument may be helpful in other cognitive skills, but they can't be reduced to argument (even if we stretch what we mean by 'argument' rather broadly). To put the underlying point in pithy terms: good argument does not entail good judgment. It is also simply false that the supreme academic aspiration is to defeat bad arguments with better ones (here are some rivals: to find truth, to be the first to make a discovery, to contribute to human flourishing, etc.)

Interestingly enough, rather than focusing on the cultivation of sound judgment, Allen focuses on trustworthiness ("to prove themselves trustworthy to one another.") Anybody familiar with my beloved analytic philosophy knows that being good at argument does not entail trustworthiness. (In fact, it raises anew Aristofanes' suggestion that argument supports sophistry.) It's also a peculiar to turn this into the central virtue of democracy and higher education's contribution to democracy. While it is no doubt true that mutual trust or trustworthiness facilitates healthy democracies and its existence is, in turn, facilitated by healthy democracies. And it is also undeniable that all education involves complex, trusting commitments. But trust is fundamentally built on perhaps necessary 'leaps' unsupported by full evidence (even if rational). Trusting relationships are paradigmatically asymmetrical--the language of 'trustees' and 'trustors"+ do not indicate equals (which is why (recall my reading of Hazony) trusting in steadfast God is so important to the ancient Hebrews)--and so, fundamentally, a-democratic (as distinct from undemocratic).

Perhaps, Allen wishes to promote higher education as the place where trustworthy citizens are cultivated who can be authoritative, intellectual leaders inside the academy and in larger society. But there is a two-fold problem here: first, trustworthy citizens may well embrace an impoverished intellectual life defined by promoting practices and virtues appropriate to a nation of book-keepers. It is especially peculiar that Allen wishes to cast aspersions on disdainful mockery. Not to put too fine point on it but the intellectual life of democracies thrives on mockery, satire, and ad hominem attacks. (I have added satire for good measure.) To eliminate mockery, satire, and ad hominem attacks is to ban Aristofanes, the tragic poets, and Plato from Athens. (Maybe only dour Thucydides would be left.) There is some truth in the old saw that dictators fear the comedians most. Second, authority is -- as Hannah Arendt teaches -- intended to generate a form of obedience  not conversation nor rational persuasion (recall also) it is, thus, anti-intellectual and anti-democratic at once.

An impatient reader may wish to interject that surely we wish to defend true freedom of speech at universities. And, surely, shouting down a speaker is inimical to reasoned debate and thus free speech. But there are a whole bunch of other rules that are presupposed in making serious, intellectual life possible: and Murray does not play by those rules. Here  it is important to reflect briefly on the Bell Curve--a book I have taught in my philosophy of social science courses a decade ago (I contextualized it with selection of papers from Intelligence, Genes, and Success: Scientists Respond to The Bell Curve, I warmly recommend Glymour's contribution.)  In order to make my point I quote the closing paragraph of the most thorough and searching investigation of the methods deployed in the book (recall). I have in mind Goldberger and Manski's review:

A serious scientific book should be the culmination of a program of research that has been subjected to external scientific scrutiny, revised appropriately in the light of that scrutiny, and iteratively honed into a well-reasoned and credible final form. In this paradigm, research that purports to be scientific would first be reviewed on its scientific merits. Only if that review is passed successfully would society at large be concerned with the research.
HM and their publishers have done a disservice by circumventing peer review. The Bell Curve was sprung full blown without external external scientific scrutiny, but with beautifully orchestrated initial publicity. A vast stream of reactions in the general media followed immediately (e.g., New York Times Magazine, October 9, 1994; Newsweek, October 24, 1994; Time, October 24, 1994; The New Republic, October 31, 1994). Through essays like ours, a process of scientific review is now under way. But, given the process to date, peer review of The Bell Curve is now an exercise in damage control rather than prevention. (776)

While one can debate Goldberger and Manski's view that works first need to be reviewed on their scientific merits and only then popularized (this undoubtedly would also diminish the intellectual culture of a liberal democracy and also engender a strong status quo bias), it is undeniable that Murray's work is promoted by powerful financial interests that seek to undermine some of the rudiments of a democratic culture (including equal respect for all citizens) and have no respect for the integrity of scientific conduct. Now that we live in the age of resurgent white nationalism we can also see that the consequences of this circumvention of ordinary rules is not a trivial matter. The damage control will be harder and harder as smart white nationalists will bait would be critics into an expanding cycle of debates that are designed to make their views respectable and worth considering.** And, in fact, Allen's suggestion that the protesters should have read his work and figured out how to critique it plays into this undermining process that only requires ever more resources in damage control. There is really no reason why universities that are to be entrusted with fostering a vibrant democratic culture should support this way of attention and agenda setting. (That is, giving folk like Murray any public attention at all is by now probably a tactical and strategic mistake.***)

In addition, there is an ongoing, concerted public campaign to discredit America's universities in outlets whose whole financial model seems to rely on not just making fun of liberal politicians (that's fine by my lights) but also producing (nostalgia fueled) outrage against higher education, which facilitates a political program of budget cuts of higher education and a skeptical attitude toward climate science and (in an earlier age) insulate the tobacco industry from its responsibility from the lung cancer epidemic (etc. [the list of etc. is long]). Allen addresses these facts only obliquely ("It also means that it is better to pursue argument with the other side than disdainful mockery of its views and to argue on the merits rather than make ad hominem attacks. This goes for both left and right.")

We urgently need to rethink what the nature and ethic of the academy is going to be in ethno-nationalist democracies. Its history of embrace of racial quotas, racialized science, and eugenics in an earlier ethno-nationalist-democratic age does not inspire confidence. While I share with Professor Allen a distaste for and distrust of the terrifying mob,  if we are to re-imagine the goal of making a college the best it can be with humanity and clarity this requires a frank acknowledgment of the dangers that accompany the calls for civility (recall my piece; indebted to Leigh Johnson & Ed Kazarian). After all, we learn from the tradition of political thought that "uncivil conduct and speech" (I am quoting from Amy Olberding's excellent essay), if not the mob, is not the cause but itself a symptom of disorder. 

 That is to say, I agree with Allen that our civic culture is badly debilitated. What I do not believe is that we will replenish it by understanding universities in terms of free speech.++ If we wish to keep school open, we must always be willing to consider closing the doors to some folk.*** As Plato teaches in the Republic, academies are not public fora but they are structured by entry requirements and requirements of the curriculum. Thus, university speech is not at all free in the sense of the legal doctrine of free speech (although there are important connections). Rather, there are many subtle, different obligations and expectations on, say, the corporate stance of the university, the speech of professors in the seminar room (as opposed, say, to offering expert testimony to Congress), noisy student activists, creative student activists-artists, and students in the class room. Each university community needs to re-negotiate and re-articulate these expectations with each other. One could do little better than to start reflection on these issues with Jacob T. Levy's essay (recall; see also my responses here and here.)

 

Impostures Unmasked

Men's inclination to the marvellous has full opportunity to display itself....It is true; Lucian, passing by chance through Paphlagonia, had an opportunity of performing this good office. But, though much to be wished, it does not always happen, that every Alexander meets with a Lucian, ready to expose and detect his impostures.--David Hume, "Of Miracles."

I agreed with Art [Goldberger] that the Bell Curve was bad social science and ethically suspect as well. However, I wished that the book would just go away. Rather than make a large personal effort, along with many others, to debunk the Bell Curve, I would have preferred to write new papers and make positive contributions. Nevertheless, Art persuaded me that the challenge had to be met. So we both worked for several months to hone our arguments and write the JEL piece. In retrospect, I am proud of the result. I think we may have written the most careful and scientifically accurate critique that appeared during this sorry period for the social sciences. And I was happy to have coauthored with Art on a subject that he cared about perhaps more than any other.--Charles f. Manski "Arthur S. Goldberger 1930-2009: A Biographical Memoir" 2013. 

There are  genuine opportunity costs to engage with bad arguments, bogus science, impostures, and demagogues (as well as the self-deceived); it may also be very unpleasant to do so. Many of us, hard-working scholars and professors, skirt our duties to society in this respect. We should always be grateful to our peers who undertake this often thankless task. Without those peers, malicious and damaging falsehoods would go entirely unchecked. I want to use this occasion to salute Arthur Goldberger and Charles Manski for their beautiful and thorough (as well as devestating) review of The Bell Curve.*