The week of April 18: rating a ratings agency’s ESG ratings, inflation, taxation, Twitter, Disney, and much, much more.
The week of April 18: rating a ratings agency’s ESG ratings, inflation, taxation, Twitter, Disney, and much, much more.
E SG, a variant of “socially responsible” investment, is a discipline — too kind a word, really — under which potential (or actual) portfolio companies are measured against environmental, social, or governance criteria designed, to no small extent, to support the pretense that the subjective is objective. And it is a pretense made all the worse by the manner in which ESG is being used to further a political agenda without the inconvenience of asking voters what they think. ESG is also a good and sometimes extremely profitable business — an invitation to rent-seeking, which has been eagerly accepted by any number of financial businesses, lawyers, accountancy firms, “consultants,” and the like. To help understand why ESG has taken off so quickly, just look at the flourishing ecosystem that it has spawned.
There’s a long, long way to go, but there are some signs of a pushback.
Utah’s governor and its federal lawmakers are objecting to S&P Global’s move to publish ESG scores for U.S. states, calling it an undue politicization of the ratings process.
In a letter sent to the firm on Thursday, the politicians — all Republicans — lay out a lengthy rebuke of S&P’s move to release environmental, social and governance assessments, or a so-called ESG score. Despite Utah’s results falling in line with many other states, the officials argue S&P should focus strictly on financial fundamentals . . .
S&P’s ESG indicators include categories like human rights, social integration, low-carbon strategies, climate measures and sustainable finance.
The ratings agencies have, if nothing else, a keen nose for a money-making business, and that, plus in all probability, a leftwards drift within S&P (as in so many parts of today’s capitalist system, from corporations to proxy advisory firms), probably explains why S&P is, to quote from the letter (which in addition to being signed by Utah’s governor and its federal politicians, is also signed by its lieutenant governor, attorney general, attorney general, state treasurer, and state auditor) is publishing “ESG credit indicators to ‘augment’ its credit ratings.” Augment? As is noted in the Utah letter, “traditional public finance entity credit ratings already incorporate financially material factors, including ESG factors.”
To be fair, (and as Utahns acknowledge), S&P does concede that “strong creditworthiness does not necessarily correlate with strong ESG characteristics and vice versa.” If that’s the case, what is going on? Perhaps too polite to talk about the profits to be made out of the ESG business, the Utah team focuses on politics, and, more specifically, the way that “S&P’s ESG credit indicators politicize what should be a purely financial decision.” As the letter writers explain, this is the sort of politicization that “has manifested itself in the capital markets where, for example, banks are pressured to cut off capital to the oil, gas, coal, and firearms industries.”
It’s a parallel worth drawing. It’s not unreasonable to suspect that a longer-term aim of ESG “augmentation” and similar scoring techniques is to increase the cost of capital for states perceived as doing the “wrong” thing.
To quote from the letter:
We are concerned that the normative assessment and disclosure of ESG factors will unfairly and adversely affect Utah’s credit rating and the market for Utah’s bonds, especially where the alleged indicators are not indicative of Utah’s ability to repay debt.
In a separate statement, Utah’s treasurer commented that
ESG is about controlling and forcing behaviors. It attempts to do through capital markets what activists and their government allies have been unable to do through democratic processes. It is a political score that, intentionally or not, can result in market participants using economic force to drive a political agenda.
More Utahn politeness. If there’s ever an “or not” it’s only rarely. ESG has become a device to use economic muscle to force through change of a type or at a pace (or both) that voters would reject. As such, it is a political project, and one with a distinctly post-democratic feel. To be sure, there are ESG-type issues that have a bearing on investment return or the creditworthiness, but they ought to be picked up by conventional analysis that has no need of those three magic initials.
Utah’s dispute is with S&P, but it’s only fair to note that S&P is not the only ratings agency playing the ESG game. The ecosystem is what it is.
Sustainability and climate change are fundamental considerations to seize opportunities and manage risk in today’s global capital markets. Our data and insights across Environmental, Social and Governance (ESG) and climate risks, as well as sustainable finance, can help you achieve the objectives of the sustainable development agenda.
Or Travel to Fitch’s website to find, yes, Sustainable Fitch:
“An objective and comprehensive assessment of ESG performance at Entity, Instrument, and Framework level with superior coverage and granularity. Independent data and insight that will set a new standard and will allow a pure ESG cross-comparison view”.
Oh, the granularity!
But back to Utah: Overall, the letter is well worth reading, not only for the manner in which its authors confront the use of ESG for political ends but also for the way they highlight — let’s be kind — the intellectual confusion within ESG (such as, and this is an issue that has been around for a while now, how to balance the E, S, and G). And then there’s the question of what the Utahns refer to as some “truly baffling” ESG scoring:
For example, S&P gave Russian-controlled energy producers higher ESG ratings than similar entities in the U.S. Russian energy giants Gazprom and Rosneft outscored American energy companies ExxonMobil and Chevron on S&P’s ESG scale. This despite the fact that Vladimir Putin’s Russian government is the majority owner of Gazprom and owns a 40% stake in Rosneft . . .
Following renewed aggressive sanctions by Western governments, any investor who relied on S&P’s ESG ratings will be left to wonder whether those ratings—the “social” component in particular—accurately captured the actual risk attributable to the Russian government’s longstanding and documented disregard for human rights and international law.
There’s more in the same vein, including a reference to state-owned China Petroleum & Chemical Corporation’s ESG score, another sign, perhaps, of growing awareness of China’s — how to put this — anomalous position within certain corners of the ESG universe. Some of the more prominent advocates of ESG are also active in either investing in China or encouraging their clients to do so, a combination that is impossible to justify. ESG, China: Choose one (or neither).
It would be hard to resist the temptation to throw in a few digs at the record of the ratings agencies, including S&P, especially the way in which their failings contributed to the financial crisis. The Utahns did not resist that temptation. They also found time to include this:
S&P admitted in its $1.375 billion state Attorney General and Department of Justice settlement that it succumbed to conflicts of interest in rating these products by prioritizing business relationships with issuers over accuracy in its models and ratings . . .
It therefore troubles us to learn that S&P may be repeating the mistakes of its past by once again prioritizing peripheral concerns ahead of its core mission.
Some elements of the letter — such as the suggestion that S&P’s membership of the Net Zero Financial Services Providers’ Alliance might raise antitrust issues — look to me to be a stretch, as does the “demand” that S&P withdraw its ESG-credit-indicator card, which is, after all, an expression of opinion. On the other hand, the declaration that the state will not cooperate with S&P on this project is to be welcomed.
The letter concludes with a list of questions for S&P, which (I’d guess) will likely go largely unanswered. The most interesting are those that focus on the methodology adopted by S&P. Just to read them is to gain an impression of the shaky foundations on which so much of ESG rests. And the answer to that shakiness is not the attempt to “standardize” ESG in the way that the SEC would clearly like to go, something touched on by Richard Morrison (who was writing about private companies, not states, but his broader point works for either) in an article for Capital Matters in May last year.
An extract:
Some advocates suggest ESG guidelines are just common sense or that, even if they are complicated, it will just require getting a team of experts in a room together to figure out the details. But that is a dangerously false assumption. . . . Beyond that, handling these issues will inevitably involve difficult trade-offs. No well-intentioned geek squad can solve these problems for us and nor should they be given the power to do so.
Should we, for example, insist that banks finance only zero-carbon-emissions projects, or should we allow them to help poor countries to develop more-affordable sources of energy?
I might dissent from Richard’s generous inclusion of that “well-intentioned.” Sometimes, perhaps, they are. Sometimes. But often they are not. The drive toward standardization is driven, above all, by the recognition of the power that it confers on the standard setters.
A number of the Utahns’ questions are designed to find out how well some of S&P’s ESG assumptions have worked out.
How, if at all, and to what extent did your models relating to or incorporating “climate transition risk” predict the U.S.’s and Germany’s recent calls for increased domestic energy production following Russia’s invasion of Ukraine?
I think I can guess.
It would be even more helpful to know if those same models also incorporated the economic danger to Germany arising out of its unhealthy dependence on Russian oil and, particularly, gas. That dependence grew directly out of Germany’s climate transition (and was made worse by so many of its voters’ neurotic aversion to nuclear power). The dangers that went with a transition structured in this manner have been evident for years to anyone paying attention.
It would be interesting to know how they were incorporated in S&P’s model, say, a decade ago.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 63rd episode David is joined this week by the architect of the landmark 2017 corporate-tax-reform bill, Congressman Kevin Brady of the House Ways and Means Committee. They discuss current economic conditions, the supply chain, the labor shortage plaguing our economy, and even find a little green shoot of optimism.
The Return of the Regional Seminars
National Review Institute is back on the road with its biennial Regional Seminars. This year’s series, titled “Creating Opportunity,” will feature panel discussions and one-on-one conversations that make the moral and practical case for free enterprise.
The next will be held in New York City on May 2. Featured speakers include William B. Allen, David L. Bahnsen, Lindsay Craig, Veronique de Rugy, Rich Lowry, Douglas Murray, Ramesh Ponnuru, and Peter Travers.
We hope you will join us. You can learn more and purchase tickets here.
The Capital Matters week that was . . .
Taxation
You have to hand it to the leftists: They never give up. Despite the demise of President Biden’s Build Back Better plan — along with its wealth-tax proposal — the administration is back again with yet another idea for taxing wealth. They’ve just given it a new name.
The Treasury Department recently released its explanation of the administration’s FY 2023 revenue proposals. The so-called Green Book lays out exactly how the administration proposes to raise $1.628 billion in new taxes over the next ten years. In addition to raising the corporate-tax rate to 28 percent and pushing the top personal income-tax rate to 39.5 percent, the proposal creates what effectively amounts to a wealth tax. Treasury claims that the new tax will raise $239.5 billion in revenue over the next decade . . .
Only 13 states tax groceries at all, and many of them tax them at a lower rate than the general sales tax. The rationale behind not taxing groceries is usually that doing so would disproportionately harm the poor (since food takes up a larger proportion of their spending), and basic necessities such as food should not be taxed.
Walczak argues convincingly that the basic argument for exempting groceries from the sales tax is incorrect . . .
After the economic pain caused by Covid-19, many state governments decided to offer residents some relief in the form of tax cuts. Kansas permanently reduced its grocery tax. Idaho, Indiana, Iowa, and Utah cut their income taxes, and Mississippi flattened and cut its income tax.
Yet while many red states pursued permanent tax relief, blue states such as Illinois went a different route, opting for temporary relief. Illinois enacted short-term cuts to gas, grocery, property, and other taxes, many of which expire shortly after Election Day, and all of which will expire by July 2023, save for an expansion of the Earned Income Tax Credit . . .
Energy
Much as I can understand the political reasons why the administration might like to attribute our current inflation woes to Putin’s Price Hike™, the White House is going to have to work much harder if it expects that narrative to stick. Persuading Americans to forget that prices were already rising strongly before the run-up to the invasion of Ukraine (something Brian Riedl discussed in a recent piece for Capital Matters) won’t be easy.
And while it is true that the disruptions following the invasion will push up inflation still further — and not only in the energy space — this administration is going to find it hard to convince people that it is doing what it can to keep energy prices down, especially when there is news like this . . .
Sri Lanka
This slow-motion train wreck first began in November 2019 when Gotabaya Rajapaksa won a decisive victory in the country’s presidential elections. He immediately placed family members into key government positions and suspended Parliament. Then in August 2020, his Sri Lanka Podujana Peramuna party — the Sri Lanka People’s Front — posted a landslide victory. The win gave Rajapaksa the ability to amend the country’s constitution, which he quickly availed himself of. In total control, President Rajapaksa and his brother Mahinda, the prime minister, went on a spending spree that was financed in part by Sri Lanka’s central bank. The results have been economic devastation. The rupee has lost 44 percent of its value since President Rajapaksa took the reins, and inflation, according to my measure, is running at a stunning 74.5 percent per year. Last week, Sri Lanka announced that it was unilaterally suspending payments on its external debt. These economic developments have led to Sri Lankans protesting in the streets and a government in disarray . . .
Twitter/Musk
A year after being named Time magazine’s person of the year, Elon Musk is attempting to acquire Twitter.
To listen to Musk’s critics, you’d believe it’s an act almost on par with Hitler invading Poland not long after being named Time’s man of the year in 1938.
A writer for the left-wing website Salon worried that a Musk takeover of Twitter would enable fascism in America. A New York University journalism professor lamented that posting on Twitter with the threat of Musk looming feels like partying at a Berlin nightclub “at the twilight of Weimar Germany.” Former labor secretary Robert Reich warned, “This is what oligarchy looks like.” And so on . . .
Twitter’s poison-pill-swallowing board is coming under some fire.
Yahoo Finance ran an interesting interview with former SEC Chairman Harvey Pitt.
Given his former role, he notes that, from a regulatory perspective, Musk’s approach to his accumulation of a stake in Twitter had not been . . . ideal . . .
Writing for NRO last week, David Harsanyi noted how “‘content moderation’ is little more than an effort to control political discourse,” and then ran through some telling reactions to the prospect of a bid by Elon Musk for Twitter.
Do read the whole of David’s piece, but I’ll add another reaction to the collection he has already assembled, this one from Timothy L. O’Brien, writing for Bloomberg (an organization with absolutely no connection to any billionaire) . . .
It is no great surprise that a writer for the Financial Times’ relentlessly sanctimonious “Moral Money” (the self-congratulatory name is something of a giveaway) has weighed in on the Twitter fight.
The writer of the article, Simon Mundy, raises some points about Elon Musk’s record that would indeed be of concern to investors who throw ESG considerations (a discipline that rates companies partly by how they measure up against various environmental, social, and governance criteria) into their decision-making process, and quite possibly not just them.
Fair enough.
This, however, is not . . .
Rejecting the proposal on the grounds that Musk hadn’t explained how he was going to pay for the stock came with the advantage for the board that it could sidestep any awkward argument about what Twitter is worth (even if it could be said that its earlier adoption of a poison pill showed a certain, uh, anxiety that Musk might indeed find the cash). Now that discussion cannot be avoided, and it’s going to have to involve money. Blathering on about, say, the wider societal implications of a Musk-owned Twitter won’t do the trick . . .
Inflation
Steve Forbes, Nathan Lewis, and Elizabeth Ames:
How do countries control inflation? The answer is: very badly. The misunderstanding of money that leads governments and central banks to devalue currency too often means they’re ill-equipped to put the Inflation Genie back in the bottle. History is littered with attempts to end monetary disasters that have failed and frequently made things worse.
This is because policymakers are usually unable, or unwilling, to acknowledge the real reasons why their currency has lost value. Instead, they blame markets: People are spending too much money! Businesses are gouging! The economy is overheating! Do something! . . .
If ever a Federal Reserve has been the stock market’s friend, it has to have been Jerome Powell’s Fed. However, if the recently released minutes of the Fed’s last policy meeting come to pass, the central bank will soon become anything but.
Not only will markets have to learn to cope, at least for a prolonged period, without the benefit of the so-called Fed put, whereby the central bank can be counted upon to support the market at a time of weakness. They will also have to deal with a Fed that’s intent on draining large amounts of liquidity as part of its effort to regain control over inflation . . .
As the governments and central banks of some of the world’s biggest economies gear up to tackle the outbreak of grave inflationary pressures, the rest of us need to recognize that getting inflation back under control is going to be a very difficult and messy business.
For all the assurances by central bankers that they can engineer a soft landing, such an outcome is unlikely. On the contrary, it is far more probable that we will face a difficult and long war against inflation. And like in any war, there will be considerable collateral damage. Making matters worse, the generals leading the campaign are, at best, an irresolute bunch. Some of them have even helped create our present problem by advocating low-interest rates for far too long and deploying quantitative-easing far too often.
‘Managing’ the Economy
By almost any meaningful measure, you won’t see radical changes in U.S. economic performance as a result of a change in which party holds the presidency or controls Congress. For all of the moralistic talk and preening homiletics, the things that strongly and immediately affect our economy are mostly outside of the control of politicians. The Trump administration saw both a radical collapse in the U.S. economy and a dramatic recovery — each driven by Covid-19, with government policy playing a mostly secondary role. George W. Bush wore the blame for the subprime meltdown, which had almost nothing to do with the actions of his administration and was rooted in policy decisions going all the way back to the 1930s. Bill Gates and Marc Andreessen had a lot more to do with the economic boom of the 1990s than Bill Clinton did. Et cetera ad nauseam.
We have real problems, and we are not going to make things better by means of empty-headed moralistic fairy tales. We are going to learn that lesson, eventually — and probably learn it the hard way.
Supply Chains
As technology develops, ATI will be able to detect more types of track defects — but regulators must allow the technology to develop. By rejecting Norfolk Southern’s request despite excellent safety results, the FRA is slowing the modernization of American freight rail and preserving union jobs. When President Trump was in office, the FRA was enthusiastic about ATI. Now that the self-described “most pro-union president” is in office, the interests of organized labor come first.
If the federal government continues to treat our transportation systems as jobs programs for union members, expect supply-chain problems to get worse in the years to come.
New York City
The chart above, made by Apollo Global Management chief economist Torsten Slok, shows that median monthly rent for an apartment in Manhattan has fully recovered from the pandemic. Manhattan rents are rising at a 30 percent annual rate.
The pandemic did not usher in a lasting decline in cities — not even in New York . . .
Disney
Walt Disney World’s setup in Florida is, indeed, unusual, but it doesn’t quite make sense to call it a “carve-out.” Properly understood, a “carve-out” is a rule that is applied differently to entities of a similar or identical nature: The Walt Disney Company, for example, enjoys a brazen carve-out in Florida’s tech-regulation bill: an exemption for Disney+ that was not granted to Netflix, Hulu, or HBO Max. By contrast, the rules that apply to Walt Disney World could be better described as “tailored,” for, despite the insinuations of many Florida Republicans, Walt Disney World’s accommodation is unique not in its type but only in its particulars. As it happens, Florida has 1,844 special districts, of which 1,288 are, like Walt Disney World, “independent.” . . .
Disney went to the mattresses. And it did so not to serve its shareholders, enhance its profitability, protect its intellectual property, or align itself with its vast and politically diverse customer base.
This was, shockingly, an iconic American brand making itself into a free-floating weapon of woke cultural politics in response to the social and political influence of a small number of vocal progressives.
Like so many companies before, Disney calculated the risk/reward of gratuitously taking up a left-wing political and cultural fight and considered it all reward, no risk. The Florida legislature decided to convince it that it was wrong . . .
Texas
“$20,000,000,000. That’s how much our property taxes have risen under Abbott,” complains Beto O’Rourke, who is running for governor Greg Abbott’s job this year.
Twenty billion dollars is indeed a lot of money. Depending upon when you start counting, it could be even higher; Texas paid $49.1 billion in fiscal 2014 (the year before Abbott took office) and is paying $73.2 billion in 2021, which is $24.1 billion, a 49 percent increase.
The casual viewer might think that O’Rourke is saying Abbott raised property taxes, but that’s not what is happening here.
Regulation
A telling feature of the Justice Department’s appellate filing is that it reportedly did not include a request to stay the district court’s order and reinstate the mask mandate pending the outcome of the appeal. This is highly unusual, especially in a case where public-health authorities claim that reinstating the mandate is “necessary for the public health.” It strongly suggests the CDC is more concerned with preserving its prerogatives for the future than in protecting the public from a current health emergency — a motive that was confirmed by Jen Psaki in a Wednesday night interview where she said the appeal was important “to ensure the CDC’s authority and ability to put in mandates in the future remains intact.” . . .
If a menthol ban substantially reduces smoking, that would be bad news for government revenues but good news for public health. But if smokers simply substitute non-mentholated cigarettes, consumers will have fewer choices and the impact on both government finances and public health would be negligible. And if, as experience strongly suggests, many menthol smokers turned to smuggled products, everyone loses — except the smugglers.
State lawmakers understand that a reduction in the sale of legal, taxed cigarettes will reduce their cigarette-tax revenues. That is straightforward enough. But the revenue hit is much larger than that.
Climate
Rather than looking at shipping’s proportion of global carbon emissions, it’s more helpful to think of the rate of pollution per unit of freight. There is no more fuel-efficient and environmentally friendly way to transport one ton of freight over long distances than by water. Airplanes and trucks use much more fuel per ton of freight. Cargo ships benefit from massive economies of scale since their capacity is so much higher than any other mode of transportation, and the physical properties of water make things easier as well, requiring less energy to move the same amount of stuff.
Thinking of the rate of pollution, not the total, matters because ocean shipping has substitutes. It is true that slow steaming (the industry term for traveling at reduced speed) would reduce pollution, but it can add a week to a transoceanic journey, which would also make ocean shipping less attractive to shippers who handle time-sensitive freight. They aren’t just going to not ship their goods if ocean shipping doesn’t meet their needs. They’re going to put their goods on planes, trains, and trucks instead, which is worse for the environment . . .
The problem with the LNG approach to reducing carbon emissions for ocean carriers is that environmentalists would still pitch a fit because it would require more natural-gas production and exploration. LNG burns cleaner, but it’s still a fossil fuel, which environmentalists oppose because it isn’t renewable. It’s commonly extracted through fracking, which environmentalists want to ban. Additionally, LNG must be transported — by large oceangoing ships. If environmental regulations make shipping more expensive and service less frequent, it only becomes harder to move LNG and facilitate the transition to a cleaner fuel source.
If environmental regulations increase transportation costs around the globe, then it may become cost-effective for businesses to move production closer to home to avoid higher shipping costs. Hooray, we’re bringing jobs back to America! Well, not so fast . . .
Please note that there will be no Capital Letter next week because of travel commitments.
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