Flooded

Some economists also warn that Dodd-Frank does not go far enough to regulate capital-poor, risk-rich “shadow banks,” such as investment banks and hedge funds, and to prevent the shadow-banking collapses that fueled the financial crisis. “We’re not dealing with the capital problems in these large institutions,” Eisenbeis says. “If you have sound financial institutions, you can weather a storm in a way that you couldn’t otherwise.”

Moreover, in spite of a pricing plunge that continues in many metro areas, the real-estate market remains artificially inflated and in jeopardy of further collapse, a number of economists say. That’s because Washington stepped in to stop the market free-fall by taking receivership of mortgage-lending giants Fannie Mae and Freddie Mac. As a result, the government is now underwriting 95 percent of residential loans and essentially using taxpayer dollars to guarantee against default.

Lending standards have tightened some, and the Obama administration is pushing to tighten them even more, but economists say that the mere presence of a government backstop induces overly risky behavior. That leaves Congress and the White House with a grim choice: Keeping some form of government guarantee in place could set off another wave of bad loans, yet quickly removing the guarantee could send housing prices into yet another heart-stopping fall. “There’s a sense in which the housing risk, which really brought down the financial sector, has been transferred to the government,” Viral Acharya, a finance professor at New York University’s Stern School of Business, told NJ. “But the risk has not been fixed.”

The Obama administration, it is fair to note, is far more optimistic that the crisis and ensuing reforms have gone a long way toward reducing undue risk in the financial sector. Officials say that capital levels have improved dramatically from precrisis levels, housing loans are harder to come by, credit in general is of higher quality, and further implementation of Dodd-Frank will brighten the picture even more. “The core of the American financial system is in a much stronger position than it was before the crisis,” Treasury Secretary Timothy Geithner told reporters at a Bloomberg breakfast late last month.

UNNATURAL DISASTERS

Ordinary Americans are the inadvertent bearers of financial risk. After all, relatively few work on Wall Street or take out loans they can’t afford. But environmental risk is something Americans inflict on themselves—and on the world. The mother of all environmental risks is climate change. As greenhouse gases collect in the atmosphere, the odds increase that the planet will experience dramatic rises in temperatures, sea levels, and extreme weather events such as droughts and floods. Any of those changes will come with enormous costs.

Under many frighteningly plausible scenarios for a climate-altered future, increasingly frequent heat waves will drive up Americans’ air conditioning and medical costs and threaten the lives of senior citizens. Wilting or flooded crops across the Great Plains will plunge farmers into financial distress and push grocery prices up. Western states will scrape and fight for disappearing water reserves, and the winners will pay through the nose. Erosion and rising seas will force millions of coastal residents to relocate inland.

The most frightening risk is that the effects could come much more quickly and severely than scientists forecast in their most probable scenarios—disrupting food supplies, displacing large swaths of the population, and setting off a feedback loop of greenhouse-gas release that could prove nearly impossible to stop.

Economists offer a wide range of figures for what the drivers of gasoline-powered automobiles, the consumers of coal-fired electricity, and other fossil-fuel burners should pay to offset the climate risks they are taking. The Obama administration, in an annual economic report issued in February, pegged the “social cost of carbon” in the range of $5 to $67 per ton of carbon dioxide. America is liable for mean damages of $1 trillion over the next 40 years because of climate change, according to researchers at Sandia National Laboratories. Factor in the low-probability, high-impact risk of a catastrophic climate shock, other economists say, and the premium could be substantially higher.

“This problem belongs to a very small class of phenomena where it’s very difficult to put a bound on the damages, because the whole planet is involved,” says Martin Weitzman, a Harvard economist who studies the pricing of climate risk. Complicating matters further, he adds, is the inability of Americans—and most other residents of democracies—to weigh the potential far-off costs of their actions today. “The average person throughout the world does not see climate change impacting their daily life,” he says. “It’s just too hypothetical.”