If you are over the age of 40, there is a good chance you remember where you were on September 15 2008, the day Lehman Brothers went bust. It was one of the first of many shocking moments during the last global financial crisis, a searing time of bank runs, crashes and bankruptcies when big economies tumbled into some of their deepest recessions since the Great Depression. Stunned Lehman staff, who left the 158-year-old investment bank’s offices carrying their belongings in cardboard boxes, came to symbolise the millions who lost their jobs, homes and life savings in a disaster that destroyed trillions of dollars of wealth.
There were multiple culprits for the mayhem but, as with so many past financial debacles, the property market was implicated. In 2006, the air went out of a US housing bubble fuelled by supposedly safe mortgage-backed securities that had been sold around the world and included risky “subprime” home loans. As the number of mortgage defaults and foreclosures climbed, the value of these securities plunged, saddling investors with crippling losses and prompting panic in financial markets.
In the months after the crisis hit, government bailouts and sweeping reforms began to put the battered financial system back together. Today, big banks are better capitalised. Markets are better regulated and investors more protected as a result of those reforms. And yet each month now brings warnings with echoes of that strife. Fears are growing that property markets could again be roiled, this time not by risky lending practices but by rising numbers of climate-related disasters putting pressure on insurers and other critical financial institutions. “Property values will eventually fall — just like in 2008 — sending household wealth tumbling,” said Next to Fall, a December report on climate change and insurance from the then Democrat-chaired US Senate Budget Committee. “The United States could be looking at a systemic shock to the economy similar to the financial crisis of 2008 — if not greater.”
In January, the Financial Stability Board, which was set up to keep an eye on the global financial system after the 2008 crisis, said insurance was becoming more costly and scarce in disaster-prone areas and “climate shocks” could set off wider market turmoil. In early February, US Federal Reserve chair Jay Powell warned that the Fed was also seeing banks and insurers pull out of risky areas. “If you fast forward 10 or 15 years, there are going to be regions of the country where you can’t get a mortgage. There won’t be ATMs [and] banks won’t have branches,” he told Congress. “I don’t know that it’s a financial stability issue, but it certainly will have significant economic consequences.”
Less than two weeks later, Warren Buffett told shareholders in his Berkshire Hathaway conglomerate, which includes a string of insurers, that property cover prices had gone up thanks to a major increase in violent storm damage. “Climate change may have been announcing its arrival,” he said. “Someday, any day, a truly staggering insurance loss will occur — and there is no guarantee that there will be only one per annum.”
Then, as Europe experienced its hottest March on record, Günther Thallinger, a management board member at Germany’s insurance giant Allianz, warned global temperatures were fast approaching levels where insurers would no longer be able to operate, creating “a systemic risk that threatens the very foundation of the financial sector”.
“If insurance is no longer available, other financial services become unavailable too,” he wrote in a LinkedIn post that made headlines. “The economic value of entire regions — coastal, arid, wildfire-prone — will begin to vanish from financial ledgers,” he added. “Markets will reprice, rapidly and brutally.”
There is no single scenario for exactly how property insurance costs might lead to climate-fuelled financial upheaval. But here is one that has emerged from discussions I’ve had this year with more than 20 investors, financial analysts, regulatory experts, insurance executives, scientists and researchers.
It begins with the number of insurers pulling back from US states swelling from a stream to a flood, and not just in disaster-prone states such as California. Across the country, homeowners face soaring premiums or an inability to renew their cover as insurers confront a remorseless spate of wildfires, storms and hurricanes.
Cash-strapped governments try to plug the gaps with more last-resort insurance schemes. But these plans typically cost more and cover less, raising a chilling new reality for thousands of homeowners. The value of their family home, which had risen year after comforting year, instead begins to sink.
The contagion spreads because you need insurance to get a mortgage, so as property coverage fades, so does the presence of banks. In state after state, it becomes impossible to find a bank branch. Some lenders quit the mortgage business completely. A few begin reporting big losses. And the US is not alone. Climate-driven upheaval intensifies abroad, rattling insurers, banks and property markets from southern Australia to northern Italy. In city after city, people find themselves living in homes worth less than what they had paid for them. Each monthly mortgage payment feels like throwing good money after bad.
In a disturbing hint of past financial turmoil, mortgage defaults begin to rise, along with foreclosures and credit card delinquencies. But this time, it’s different. Unlike other financial disasters, the underlying cause of this one is not financial, it is physical, and it is not clear how it will ever end.
It needs to be said that views are far from settled about whether a warming planet will ever cause this or any other form of financial disorder.
Christopher Waller, a US Federal Reserve governor appointed during Donald Trump’s first term, has long been among the doubters. “Climate change is real, but I do not believe it poses a serious risk to the safety and soundness of large banks or the financial stability of the United States,” he told a 2023 conference in Madrid on economic and financial challenges.
Property values plunged after population declines in US cities such as Detroit without posing a threat to financial stability, Waller argued. Why would declines in coastal cities hit by rising sea levels be any different? Also, Fed stress tests that typically assumed a fall in US real estate prices of more than 25 per cent had found the largest banks could absorb nearly $100bn in losses on loans collateralised by real estate, plus another $500bn of losses on other positions.
Even experts who disagree and think there is a deepening climate-driven insurance problem don’t say this will automatically lead to the abrupt meltdowns of the 2008 crisis. Here’s how former California insurance commissioner Dave Jones, a Democrat, put it to me. “Over time you’ll see even more insurance company insolvencies, more insurance price increases and less insurance availability, more mortgage defaults, and falls in asset values and credit freezes; as opposed to a single catastrophic event or events where a bunch of financial institutions nationally go down at once.” Although, he added, “There is some risk of that as well.”
There is, however, wider agreement on one daunting point. Climate-driven financial havoc, even if it happens in slow motion, could be more menacing than past financial chaos. That’s because it would not be caused by financial failures that are typically followed by a recovery, but by global carbon emissions that the world has spent more than 30 years struggling to cut.
“This type of climate risk is not cyclical. It’s heading in one direction,” says economist Ben Keys, a professor of real estate and finance at the University of Pennsylvania’s Wharton School. “So you don’t necessarily need as big a shock, if it’s a permanent shock, to have a serious, long-term effect on house prices and other asset values.”
This idea of a persistent climate imprint on real estate, one of the oldest and most important asset classes, marks a shift in the way some experts have been thinking about the relatively new concept of climate-fuelled financial instability. The story of why this shift has happened, and what it means, may seem remote when missiles are falling in the Middle East and Ukraine, and streets in the world’s biggest economy are filling with protests against authoritarianism. But in the long run, this is the story that may matter most, if only because it is so hard to see how it finishes.
For many years, analysts have thought there are broadly two ways that global warming might affect financial stability: the physical risks of extreme weather, and the so-called “transition risks” from government policies or technologies that disrupt fossil fuel-based investments by hastening a move to greener economies.
The two threats are linked: if physical risks intensify, they could in theory spur tougher climate policies that deepen transition risks. But physical dangers often seemed the more distant of the two when the idea of climate-fuelled financial problems first arose.
Mark Campanale was an early thinker about a climate crash and transition risks. He was a 40-something sustainable investment analyst in London in 2007 when he began warning about the threat of “unburnable carbon”, the fossil fuels that could not be used if global temperatures were to be kept at safe levels.
Back then, governments were starting to act, passing laws such as the UK’s pioneering 2008 Climate Change Act, which contains a legally binding goal for reducing emissions. Campanale argued a “carbon bubble” could form as governments set emissions targets that were incompatible with the number of oil wells, coal power plants and other fossil fuel assets being financed across the world. Once policies were launched to meet those targets, he argued, investors who kept pouring money into fossil fuels could be lumbered with stranded assets and big losses. In other words, serious transition risks.
A think-tank he co-founded in 2010, called Carbon Tracker, helped to popularise the premise. In a 2011 report, it pointed out the CO₂ potential of London-listed fossil fuel companies was more than 10 times bigger than all the carbon due to be emitted until 2050 under UK climate targets. The idea took off. Financial journalists wrote about it. Academics held conferences about it. Climate campaigners deployed it and urged financial regulators to consider it.
In September 2015, the carbon bubble hit prime time. Mark Carney, then the governor of the Bank of England, gave a speech about the risk of “unburnable” stranded fossil fuel assets and the “potentially huge” exposure UK investors could face. Carney, now the prime minister of Canada, suggested companies disclose more information about their carbon footprints to help ward off a “climate Minsky moment”. That’s a sudden market collapse after a long bull run has encouraged risky debt-fuelled investments, named after the theories of the late US economist Hyman Minsky.
Carney’s speech was huge for Campanale, whose think-tank work has mushroomed to cover overfishing, chemicals and water supplies, as well as carbon risks. “I was, of course, thrilled that the governor chose to use our framing in his 2015 speech because it showed the impact of our analysis,” he says.
Others were less enthused. Climate sceptics saw a backdoor effort to sneak climate policies into banking regulations. Climate action campaigners worried Carney was putting too much faith in private markets to solve a problem requiring carbon taxes, fossil fuel use limits and other robust public policies. Many predicted such policies would never be enacted at the scale needed. And even if they were, fossil fuel asset values would gradually decline rather than crash, giving investors plenty of time to make money along the way.
Also, if there ever was a fossil fuel crash and scores of investors lost their shirts, why would it cause anything like a systemic financial crisis? That didn’t happen after the dotcom crash in the early 2000s left many shareholders in the red.
Still, Carney’s speech marked a turning point. If a central banker was taking climate financial risk seriously, not least the threat of a disorderly transition, then how could it be ignored?
And the Bank of England governor was far from alone. In 2017, eight central banks and financial supervisors, including those from China, Germany, France and the UK, launched what became known as the Network for Greening the Financial System. The group soon had more than 100 members, including the US Federal Reserve and the European Central Bank. The idea that a warming world could affect financial stability became mainstream. Suddenly, central banks were carrying out climate stress tests of banking systems that took transition risks at least as seriously as physical dangers, if not more so.
This analysis is still a work in progress. A comprehensive UN review of stress tests said last year the evaluations had broadly found that financial systems were likely to be able to cope with both physical and transition threats. But also the potential consequences were likely to be understated.
Critics have used blunter language to complain that too many stress tests are based on models that exclude risks such as climate tipping points. These are thresholds in the earth’s system that, once passed, trigger dramatic and irreversible changes, such as the loss of the West Antarctic Ice Sheet or Amazon rainforest.
“The consequence of this is that the results emerging from the models are far too benign,” the UK’s Institute and Faculty of Actuaries said in a 2023 report. “It’s as if we are modelling the scenario of the Titanic hitting an iceberg but excluding from the impacts the possibility that the ship could sink, with two-thirds of the souls on board perishing.”
More recently, Norway’s Norges Bank Investment Management, the world’s largest sovereign wealth fund, said some conventional models produced “implausibly low” estimates of physical climate risk losses while other analysis suggested far more serious consequences.
Models continue to be refined and central banks continue to work on what ECB chief Christine Lagarde last year called the “new type of systemic risk” posed by climate and environmental threats. But as it turned out, there was another type of hazard that needed to be addressed. The Trump risk.
The US administration’s rush to dismantle climate change policies since Donald Trump took office in January has been jaw-dropping. The president’s declaration of a “national energy emergency” aimed at boosting fossil fuels, and an order to again pull out of the Paris Agreement, were just the beginning.
The administration has since fired scientists at climate and weather agencies and drawn up plans to slash monitoring of greenhouse gases. Republicans in Congress have moved to repeal clean energy tax credits and other elements of Joe Biden’s climate policy centrepiece, the Inflation Reduction Act. Lee Zeldin, the administrator of the Environmental Protection Agency, said efforts to fight climate change were a “cult” as the administration began to dismantle rules restricting power plant pollution.
Separately, Trump signed Congressional resolutions aimed at overturning California’s efforts to boost electric cars and end the sale of new petrol-powered cars by 2035. As Trump’s energy secretary, Chris Wright, posted online at the time, “Climate alarmism has had a terrible impact on human lives and freedom. It belongs in the ash heap of history.”
None of this means that the green energy transition, with all its potential consequences for financial stability, is dead. Last year, worldwide investment in the transition exceeded $2tn for the first time. Nearly 40 per cent of this came from the clean energy behemoth that is China, which invested more than the US, EU and UK combined.
But the pace of global investment growth was slower than the previous three years, says the Bloomberg New Energy Finance data research group. And if the US, the world’s largest economy, is now actively doing its best to reverse the transition, it casts an uncertain light on the immediate future of the shift.
Meanwhile, signs of the physical climate risks that initially seemed more remote than transition threats have grown ever more apparent. Monster rains brought Dubai to a standstill in April last year and forced thousands to evacuate in China. Hundreds died a few months later when Typhoon Yagi roared into south-east Asia. In October, authorities in Florida were still dealing with the wreckage left by two enormous hurricanes that slammed into the state within an unusually short 13 days of each other when disaster hit the Spanish province of Valencia. More than 200 people died after a deluge dumped a year’s worth of rain in hours.
Less than three months later, the world watched as enormous wildfires brought chaos to the Los Angeles area, killing dozens and razing thousands of homes including the mansions of Hollywood celebrities.
The pace of destruction has continued this year. In March, South Korean leaders said deadly wildfires sweeping the country were the worst in the nation’s history, while Japan ordered thousands to evacuate from its worst wildfires in decades. Massive wildfires have forced thousands of Canadians to evacuate, and Australia has faced a disastrous set of floods that officials say hit economic growth. This month, authorities issued extreme heat warnings across North America, Europe and Asia.
There is no let-up in sight in a world that is growing considerably hotter.
Last year, for the first time, global average temperatures reached 1.5C above pre-industrial levels for 12 consecutive months. Some time in the next five years, there is a chance temperatures could rise to nearly 2C for the first time, scientists said in May.
None of these events has led to systemic financial instability. Trump’s market-shaking tariffs had a far bigger effect. But the growing number of disasters has begun to change the way experts consider climate-driven financial problems.
“My thinking has always been that transition risk is a bigger risk for the financial system because it can take the form of very sudden shifts that lead to huge financial losses,” says finance professor Patrick Bolton, lead author of an influential 2020 publication commissioned by the Bank for International Settlements and Banque de France that said climate change could cause the next systemic financial crisis. “But I think what we’ve seen with the LA fires and other unexpectedly destructive disasters is that we’re already now in the territory where physical risks could be a threat to the financial system.”
Banks have had a similar rethink, says a financial services strategist who has worked on climate stress testing for nearly a decade. “For years it was assumed that stranded assets and other transition risks were going to pose the biggest threat,” he told me. “But the scale of extreme weather disasters in the last few years has forced a rethink because it shows that physical risks are intensifying a lot faster than originally expected.”
Lord Adair Turner, a former chair of the UK’s Financial Services Authority who helped to redesign banking regulations after the 2008 financial crisis, has arrived at a similar conclusion, albeit from a different starting position. He always found it hard to imagine a serious financial crisis could ever be unleashed by the transition risks that solar panels or electric cars might pose for coal companies or combustion engine carmakers. But he now thinks physical climate risks might do it.
“The fact that the severity of extreme events is hurtling up at a pace which we did not previously understand, and this affects an asset category as big as real estate, could leave lenders exposed to uninsurable properties that fall in price,” he says. “If I was to search anywhere in the world for something that could produce a financial crisis, that’s where I would primarily focus.”
Turner’s interest in the subject is not academic. He chairs the UK’s OakNorth digital bank as well as European arms of the Chubb Insurance group. He was also the first chair of the UK’s Climate Change Committee advisory body. That’s a useful background, considering the new information emerging in the US about the way climate disasters are affecting home insurance. Or rather, the information that was emerging in the US.
Four days before Donald Trump’s January 20 inauguration, the US Treasury’s Federal Insurance Office released what it called the most comprehensive data on homeowners insurance compiled to date.
Its analysis of 246mn policies issued between 2018 and 2022 showed insurance was growing more costly and less available for millions of Americans, especially for those in the most disaster-prone areas.
The average cost of premiums paid by people living in places where climate-related losses were expected to be highest was 82 per cent more than in the least risky areas. Those in riskier spots also faced much higher rates of non-renewals, where insurers decline to renew homeowners’ policies.
The report included information from bodies such as the National Oceanic and Atmospheric Administration and the Federal Emergency Management Agency (Fema). Both agencies have been hit by efforts to cut the federal workforce and Trump has set out plans to start phasing out Fema.
The Federal Insurance Office would also be eliminated under legislation introduced in January by a Republican congressman, which would leave US states the sole regulators of the insurance industry. The move was backed by insurance leaders who called the office’s January report a “flawed” effort that focused too much on climate change rather than other factors that raised insurance cover costs, such as inflation, lawsuits and people shifting to risky areas.
Other insurers point out that, although extreme weather events can be significant, most have coincided with rising house prices that have so far formed a big buffer against mortgage delinquencies.
As for the risks to insurers themselves, industry leaders are quick to point out that they typically offer coverage for a single year, not the decades that a bank mortgage can last, so their financial exposure is more limited.
Meanwhile, work is being done to reshape insurance markets to make them more resilient to climate risk, push homeowners to build in less perilous places and make existing houses more resilient to weather extremes.
We must hope these efforts work. But we should also recognise that a number depend on data, analysis and shared expertise about the effects of climate change which is now under severe pressure in the US. A day after the Federal Insurance Office released its January report, the Federal Reserve said it was withdrawing from the central bank Network for Greening the Financial System that has driven so much work on climate-driven financial instability.
Two weeks later, the Federal Insurance Office said it too was pulling out of the network, in line with presidential executive orders on “Putting America First in International Environmental Agreements and Unleashing American Energy”. As the president’s agriculture secretary, Brooke Rollins, later told Fox Business, “We’re not doing climate change, you know, crud any more.” That’s because, as she said, “it’s a new day”.
Pilita Clark is an FT columnist
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