GARP SCR Climate related Minsky moment

(In the figure: Lady says: "And this is our brilliant economics department"

What is Climate related Minsky moment?

In the context of climate change, the term "Minsky moment" is sometimes used metaphorically to describe a tipping point where the financial and economic risks associated with climate change become suddenly and severely apparent, leading to a reassessment of values, investments, and financial stability. 

This adaptation of the term reflects the idea that there can be a sudden realization of the systemic risks posed by climate change, analogous to the abrupt shifts in market sentiment described by economist Hyman Minsky.

Here are some ways in which a "Minsky moment" might be applied to climate change:

1. Asset Devaluation: A Minsky moment in the context of climate change could occur if there is a sudden and widespread recognition of the potential devaluation of assets linked to industries or regions vulnerable to climate-related risks. This could include real estate in flood-prone areas, investments in carbon-intensive industries, or holdings in companies with inadequate climate resilience.

2. Reassessment of Risk: Investors, financial institutions, and businesses may experience a Minsky moment when they collectively reassess the risks associated with climate change. This reassessment could lead to a rapid repricing of assets, increased scrutiny of climate-related risks in investment portfolios, and a shift towards more sustainable and climate-resilient investments.

3. Regulatory Changes: A Minsky moment may be triggered by a sudden and significant shift in regulatory frameworks related to climate change. New regulations, carbon pricing mechanisms, or policies to address environmental risks could prompt a rapid reassessment of the financial landscape, affecting the valuations of companies and industries.

4. Insurance Industry Realization: The insurance industry, which plays a crucial role in managing risk, could experience a Minsky moment as it comes to grips with the escalating costs of climate-related disasters. A sudden increase in the frequency or severity of climate-related events could prompt a reevaluation of insurance models, pricing, and coverage, leading to broader financial implications.

5. Public Perception Shift: A Minsky moment in the context of climate change could also involve a significant shift in public perception and awareness. If there is a sudden and widespread realization of the urgent need for climate action, it could influence consumer behavior, corporate strategies, and government policies, impacting financial markets and investments.

In essence, a climate-related Minsky moment represents a turning point where the financial sector acknowledges and reacts to the escalating risks and uncertainties associated with climate change, leading to profound changes in investment strategies, market dynamics, and economic priorities.

Example of a Climate related Minsky moment:

Let's consider an example to illustrate a Minsky moment in the context of climate change. Suppose there's a hypothetical coastal real estate market that experiences a Minsky moment due to an abrupt recognition of the escalating risks associated with sea-level rise and increased frequency of storms related to climate change.

1. Initial Stability (Hedge Finance):

   - Initially, investors and property developers are optimistic about the coastal real estate market, anticipating continued demand and price appreciation.

   - Investors buy properties with the expectation that the value will increase over time, and developers borrow to fund new projects, assuming that future sales will cover their debt obligations.

2. Speculative Finance Stage:

   - Over time, the coastal real estate market becomes more susceptible to the impacts of climate change. Sea levels rise, and the frequency and severity of storms increase.

   - Despite these changes, investors and developers, relying on past trends, continue to invest and borrow, assuming that property values will keep rising, and any climate-related risks can be managed.

3. Ponzi Finance Stage:

   - The recognition of climate change risks intensifies. Coastal properties begin experiencing more frequent flooding and damage from storms, leading to increased insurance claims and declining property values.

  - Some property owners, unable to cover mortgage payments and facing declining property values, start selling at a loss or default on their mortgages.

  - Investors and developers who heavily relied on property appreciation and continued market growth find it increasingly difficult to cover their debt obligations as property values plummet.

4. Minsky Moment:

   - There is a sudden realization across the market that climate change risks are more severe and immediate than previously thought.

  - Investors, developers, and financial institutions reassess the long-term viability of coastal real estate investments. The market experiences a sharp correction, with a significant drop in property values and a surge in mortgage defaults.

  - Financial institutions that have exposure to these real estate assets face increased credit risk as property values decline and mortgage defaults rise. Investors who borrowed heavily to finance property acquisitions find themselves underwater, unable to repay their loans.

  - This sudden and severe market correction constitutes a Minsky moment, as the optimistic assumptions about the stability and growth of the coastal real estate market are shattered, leading to a rapid repricing of assets and a reassessment of financial risks associated with climate change.

This example illustrates how a Minsky moment in the context of climate change can manifest in a real estate market, where prolonged optimism and speculative behavior give way to a sudden realization of the financial vulnerabilities posed by climate-related risks.

Quiz based on a case Scenario: Coastal Real Estate and Climate Change

ABC Investments has been actively involved in the coastal real estate market, expecting steady returns and property value appreciation. Over the years, the coastal region has experienced an increase in sea-level rise and more frequent and severe storms due to climate change. ABC Investments has borrowed heavily to fund various real estate projects in this area.

Identify the potential Minsky moment scenario related to climate change risks:

Answer Options:

A. ABC Investments experiences increased demand for coastal properties, leading to higher property values.

B. Sea-level rise and storm frequency worsen, causing property damage and increased insurance claims.

C. ABC Investments continues to invest in coastal real estate, assuming climate risks can be easily managed.

D. Property values decline, mortgage defaults rise, and there's a sudden realization of the financial vulnerabilities posed by climate change.

---

Correct Answer: D. Property values decline, mortgage defaults rise, and there's a sudden realization of the financial vulnerabilities posed by climate change.**

Explanation:

In this scenario, the correct answer is D because it captures the essence of a Minsky moment related to climate change risks. The prolonged optimism, speculative investments, and heavy borrowing by ABC Investments in coastal real estate are suddenly disrupted as property values decline, mortgage defaults rise, and there's a sudden realization of the financial vulnerabilities associated with climate change. This aligns with the typical characteristics of a Minsky moment, where a market experiences a sharp correction and reassessment of risks after a period of prolonged optimism and speculative behavior.

Are there any strategies to mitigate Climate related Minsky moment?

Yes, there are strategies that individuals, businesses, governments, and financial institutions can adopt to mitigate the risk of a Minsky moment related to climate change. Mitigating climate-related financial risks involves a combination of proactive measures, sustainable practices, and strategic planning. Here are some key strategies:

1. Climate Risk Assessment:

   - Conduct thorough climate risk assessments to understand the potential impacts of climate change on assets, investments, and operations. This includes evaluating physical risks (e.g., extreme weather events), transition risks (e.g., policy and market changes), and liability risks (e.g., legal and regulatory).

2. Scenario Analysis:

   - Perform scenario analysis to model different potential climate futures and their impacts on financial portfolios. This helps identify vulnerabilities, assess resilience, and make informed decisions based on a range of possible outcomes.

3. Diversification of Investments:

   - Diversify investments across different asset classes and industries to reduce concentration risk. Avoid overexposure to sectors that may be highly vulnerable to climate change impacts.

4. Sustainable Investing:

   - Embrace sustainable and responsible investing practices, considering environmental, social, and governance (ESG) factors. Incorporate climate-related criteria into investment decisions to support environmentally resilient projects.

5. Insurance and Risk Transfer:

   - Use insurance products and risk transfer mechanisms to manage climate-related risks. This can help transfer some financial burdens associated with extreme weather events, property damage, or business interruptions.

6. Integration of Climate Risk in Decision-Making:

   - Integrate climate risk considerations into strategic planning, financial modeling, and decision-making processes. This ensures that climate-related risks are systematically assessed and addressed at all levels of an organization.

7. Adoption of Sustainable Practices:

   - Implement sustainable practices in operations, supply chains, and product offerings. This includes reducing greenhouse gas emissions, promoting energy efficiency, and adopting environmentally friendly technologies.

8. Regulatory Compliance:

   - Stay informed about and comply with evolving climate-related regulations and policies. This includes understanding and managing the potential financial implications of changing regulatory landscapes.

9. Community Engagement:

   - Engage with local communities and stakeholders to build resilience and promote sustainable development. Collaborative efforts can contribute to shared solutions and reduce vulnerability to climate-related risks.

10. Long-Term Planning and Resilience Building:

    - Develop long-term plans that account for climate change impacts. This may involve investing in infrastructure that enhances resilience, incorporating climate considerations into business continuity plans, and building adaptive capacity.

By adopting a comprehensive and proactive approach to climate risk management, entities can work to mitigate the potential for a Minsky moment associated with climate change. Recognizing and addressing climate-related risks not only helps protect financial stability but also contributes to broader sustainability goals.

#GARP #SCR #Minsky #Risk

==== End of the article ====

Why support? 

For more information, please join the LinkedIn group