The short end of the liquidity stick

Just as policymakers use countercyclical fiscal and monetary policies to cushion everyone from economic shocks, vulnerable communities deserve countercyclical liquidity policy.

image: a sketch of how I imagine public intervention in debt markets could work, from the conference I attended in May.

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I wrote most of this piece in May, on my way to a conference on debt and democracy at Stanford. While the conference focused specifically on the American muni debt market, attendees were encouraged to think expansively about the role debt markets writ large play in shaping our lives. Over the summer, I’ve been tweaking my conference intervention so that it more directly sets out a vision of the financial system I’d like to see. This essay is far from a finished product, by any means, but working on it has been particularly grounding, and I see myself continuing to tweak it as I deepen my own understanding of the financial system. As Climate Week NYC approaches, it seems like an appropriate time to “lock in” my current thought process.

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September 17, 2024

Fighting climate change has saddled us with a long shopping list: clean energy, of course, but also equitable, climate-resilient social housing, public mass transit, healthcare, and disaster preparedness infrastructures. Policymakers correctly treat building this greener, more equitable future as a primarily technological challenge; integrating renewable energy onto the grid and retrofitting infrastructure against climate shocks are difficult engineering endeavors. Insofar as the financial system is our chosen social technology for planning and developing these projects, however, this is also a financial problem. 

A big financial problem, it turns out: our financial system cannot adequately accommodate the long-term holistic planning and patient project development that decarbonization requires. Private investors don’t have much patience for these projects, and insufficient public intervention ensures that private investors’ biases will continue to skew investment away from public goods.

The global financial system, while backstopped by central bank balance sheets and built on top of sovereign debt assets (primarily U.S. Treasury bonds), is mediated by decisions taken by private investors on Wall Street and in other global financial centers. Private investors come in many flavors―commercial banks, hedge funds, private equity, and asset managers, to name a few; each has its unique role and restrictions―but, together, their judgments of investment risks and uncertainty conduct the flows of capital expenditure throughout the global economy.

Private investors seek stable returns consistent with their and fiduciary duty obligations to shareholders and creditors. But their fundamental profit motive clashes with the longer-term, lower-return debt financing that serious commitments to decarbonization require. Many institutional investors in particular suffer from high and inflexible hurdle rates, a general refusal to hold assets with riskier credit ratings, their treatment of many kinds of debt as inherently short-term speculative investments, and their lack of interest in smaller projects. These barriers to mobilizing such substantial sections of private capital bite hard where infrastructure is concerned: infrastructure assets are hard to value or trade, and are therefore hard to prepare, standardize, and aggregate into these investors’ portfolios. Left to their own judgments, private investment decisions will skew away from seemingly lower-return projects in seemingly lower-return communities. This is true nationally and globally, across asset classes ranging from municipal debt to emerging market sovereign debt to infrastructure project debt. Policymakers around the globe complain about development and climate “finance gaps,” back-of-the-envelope estimates of how much we haven’t yet spent, but what they do not often admit is that the financial system itself turns this gap into a chasm.

The communities most exposed to climate disaster―the ones hurt first and worst―are the same communities that have been structurally exploited by the financial system, the consequence of centuries of racial capitalism and imperialism. Put another way, in the language of the financial system itself, they’re on the short end of the liquidity stick: they have no steady access to the investments they need to achieve material security and, under the status quo, they won’t get that access. In emerging markets and plurality-black American municipalities alike, debt becomes a trap. I adopt the position Olúfẹ́mi O. Táíwò takes in Reconsidering Reparations―which builds on the black radical and decolonization-era “worldmaking” traditions to argue that equitable decarbonization itself, checking off the items on our green shopping list, constitutes the comprehensive reparations program that these communities deserve―to suggest that reforming and intervening in the debt-based financial system by which our futures are organized must therefore also constitute part of this global reparations program.

This castle is not built on clouds: there are concrete ways governments can creatively intervene in financial markets to support capital expenditure that carries wider societal benefits. The United States is experimenting here at all levels of government. In Montgomery County, Maryland, the county’s Housing Opportunities Commission is building mixed-income affordable public housing by buying out projects that would never have penciled out under the thumb of a private equity investor’s sky-high hurdle rate, financing project construction at a lower interest rate, and recycling property value appreciation into buying out other struggling projects. And, federally, the Department of Energy’s Loan Programs Office is using its Inflation Reduction Act appropriations to support ambitious long-term decarbonization projects by underwriting extremely large concessional loans and loan guarantees for projects that private financiers do not have the technical knowledge or risk tolerance to back alone. The public sector can stop private risk aversion from disciplining necessary investments if it tries. In this way, debt issued by the public sector is a means toward some public end―not the only means, not at all, but one with the concrete power to profoundly transform the future.

This is the politicization of finance in action: both the Housing Opportunities Commission and the Inflation Reduction Act had to be legislated into existence, after organizers fought for years to convince their governments to build these capacities to intervene in the financial system. All levels of government deserve these capacities, urgently. Where climate and housing in particular are concerned, state energy, housing, and insurance offices are understaffed, not to mention many nascent green banks. Many poorer cities have no full-time grant-writers on staff and minimal capacity to plan capital projects; many public entities depend on a small set of commercial banks to underwrite and place their municipal bond issuances. At minimum, the absence of adequate public administrative capacity shifts the ability to build communities’ desired futures onto private investors, developers, and consultants. But as climate breakdown bears down on the financial system and the material economy it undergirds, it’s not clear that there will be anyone outside the state interested in picking up the state’s slack where the capacity to plan and build an equitable future into existence is most urgently needed.

To be sure, state capacity to intervene in the financial system is, like debt, a means to an end, but not an end in and of itself. The thirty-year fixed-rate mortgage, a paradigm-shifting device to derisk housing production during the Great Depression, exemplifies how the state already instrumentalizes the financial system toward its chosen end of supporting mass homeownership. But the state’s chosen ends aren’t necessarily good, or democratically representative: redlining in zoning codes has locked marginalized communities out of homeownership and wealth-building; predatory lending punishes them for trying; affordable housing finance and voucher schemes are complex, burdensome, and rely on the whims of private developers and investors; and institutional investors’ interest in housing as an asset class contributes to gentrification and displacement absent countervailing policy action. One more negative: federal housing finance support programs have built a bloc of Americans (broadly, the middle class) who, because their wealth is tied to their mortgages, go berserk at the thought of their property values falling. This political bloc’s materialism can often manifest as blatant racism toward racialized minorities and poor people. It would be a deep, deadly injustice if state intervention into climate and decarbonization finance delivered similar societal distortions; just as finance can drive fixed capital investment, it can also cast molds for new political coalitions that might shape a kind of path dependency against progress. 

Seeing as attempts to build “future-forward” state capacity can be disciplined by private investors, by indifferent voters at the polls, and by the government itself, however, organizers and activists have their work cut out for them. A democratic politics of finance must carve out the epistemic authority to identify and prepare projects, structure financial products, execute capital expenditure, and evaluate “creditworthiness” and “financial sustainability” as far removed from private judgments of profit, risk, and efficiency as possible. A middle ground is better than nothing: the New York Power Authority (NYPA) is currently threading the needle between debt-financing new renewable energy projects and co-developing projects alongside willing private investors. I understand why public power organizers might be skeptical about this arrangement, but, considering that NYPA has never built renewables before, it makes sense to contract out firms that have, and thereby “learn by doing.” What I’d like to see NYPA and every other public energy developer and financing institution do is build out their financial engineering capacities, by hedging energy prices, strategically managing liabilities, designing power purchase agreements, and competing against private firms, among other capacities. State institutions that play in markets can help tilt both public and private investment toward public objectives. 

What organizers must militate against is governance by control board, where Wall Street-connected technocrats, often unelected, openly decide what public needs are worth spending on. Puerto Rico still has a control board, Detroit recently had one, and New York and Washington, DC, are scarred from their years under privatized administration. And the privatization of our governments continues outside City Hall, too, through tax increment finance districts and special infrastructure authorities and public-private partnerships. It’s not just a Wall Street story: of course investors made Jackson’s water crisis possible, but Mississippi’s Republican governor chose not to support the city when it most needed assistance. No matter how it is enforced, financial domination contributes to vulnerable communities’ material insecurity. Climate change exacerbates that insecurity for everyone, but the financial system’s structure will determine who actually suffers. Freedom as non-domination and material security as public abundance―these are the pillars the financial system must rest on, as with the rest of the institutions we build.

To frame this argument in policy terms: just as policymakers use countercyclical fiscal and monetary policies to cushion everyone from economic shocks, vulnerable communities deserve countercyclical liquidity policy, in the form of public and state commitments to support long-term debt-financed investments when and where they are necessary. Where Wall Street channels investment based on what risks projects pose to their bottom lines, a more democratically representative, state-directed financial system would channel investment instead based on what risks not investing poses to people’s material security. As today’s interlocking crises make so bluntly obvious, the risks of not investing are nothing less than an uninhabitable planet.

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Thanks to the friends and colleagues whose expertise I draw heavily from when I make arguments like these. This essay wouldn’t exist at all without Evan Kodra, Erika Smull, or Destin Jenkins, and many of its argumentative threads can be traced back to things I’ve learned from friends and colleagues at the Center for Public Enterprise and in the beautiful wider world of leftie state developmentalist-ish finance, geopolitics, and critical geography knowers and Phenomenal World readers.

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