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Credit Default Swaps for Carbon?

"If you liked what credit default swaps did to our economy," writes energy executive David Sokal, "you're going to love cap-and-trade." But that's nonsense. Credit default swaps created the illusion of lowered risk in the financial markets which led to highly leveraged bets between large banks and investors. Sokal's argument against cap and trade is that it overtaxes consumers and misunderstands the economic incentives of public utilities. They both might be problems. But they're not the same problem. They're not even similar.

And Sokal doesn't really try to argue otherwise. He's just tarring cap and trade by associating it with Wall Street. "Just read Title VIII of the bill, which lets investment banks, hedge funds and other speculators participate in the cap-and-trade market," he says. "They don't have emissions to cut; they have commissions to make." Last I looked, even the most pitchfork-oriented among us weren't literally trying to outlaw investment banks from participating in trading markets. Rather the opposite: The last few months in American public policy have been a series of efforts to save the banks under the theory that they play a generally useful role getting things like capital and, yes, carbon allowances, to businesses that can use them.

Sokal's solution, that we scrap cap and trade and move to a simple "cap" system based around "40-year programs" to retrofit utilities, makes far less sense than David Roberts' solution, that we pair cap and trade with policies keyed to the specific incentives of utilities. You can't have functioning markets without rules. But Sokal's solution -- rules without functioning markets -- isn't any better.

By Ezra Klein  |  May 19, 2009; 12:03 PM ET
Categories:  Climate Change , Financial Crisis  
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Um, pretty much anything can be securitized, including David Sokal.

Posted by: bluegrass1 | May 19, 2009 1:24 PM | Report abuse

I don't know if it's what he's getting at, but there is one interesting possible pitfall of allowing speculators into the cap and trade market -- the creation of bubbles in the price of emissions. If speculators think that the price of carbon allowances is likely to go up, they might bid up the price so high that companies that rely on the ability to buy allowances won't be able to operate. Shrinking supply of energy will drive up prices, and when prices are high enough those firms will be able to afford the allowances they need. And more firms bidding for allowances will drive the prices up, rewarding the speculators who drove them up. This cycle can continue, and energy prices will end up much higher than they need to be, and the speculators will make out like bandits. Finding a way to combat that risk would be a good idea, although Sokol's solution isn't very good.

Posted by: GalenHBrown | May 19, 2009 2:13 PM | Report abuse

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