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Could cap-and-trade create another economic bubble?

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A market this size means that Wall Street has a major stake in the cap-and-trade policy that emerges from Congress. The Center for Public Integrity noted in February that banks have been sending climate change lobbyists to Washington in earnest:

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Wall Street banks like Goldman Sachs and JP Morgan Chase, insurance companies like AIG and private equity firms had virtually no reps on Capitol Hill working on global warming policy in 2003; by last year, they had about 130 climate lobbyists, the Center for Public Integrity’s analysis of Senate lobbying disclosure forms shows. About 20 additional lobbyists worked for firms and organizations wholly dedicated to carbon marketing last year.

Writing in AlterNet, Teryn Norris, a Project Director at the Breakthrough Institute warns that this climate "super-lobby" could act to derail any meaningful emissions cuts. Mr. Norris writes:

The policy demands of these financial firms may vary, but most will push for weaker regulatory standards on carbon markets, larger volumes of carbon offset authorization, and provisions to increase the volatility of carbon prices, all of which would hinder progress on reducing U.S. emissions.

In particular, Norris warns that financial firms will call for emissions permits to be traded "over the counter," that is, without a third party monitoring the risk. Over-the-counter trades came under attention last year when one type of this trade, the credit default swap, helped sink Lehman Bros. and Bear Stearns.

Despite these potential pitfalls, many environmentalists are optimistic about the ability of a cap-and-trade system to curb greenhouse gas emissions. After all, it's worked once before. As the Environmental Defense Fund points out, such a program was hugely successful in limiting emissions of sulfur dioxide in the 1990s, at a cost far less than originally projected. As EDF argues, "Markets provide greater environmental effectiveness than command-and-control regulation because they turn pollution reductions into marketable assets. In doing so, this system creates tangible financial rewards for environmental performance."

But limiting sulfur dioxide, which is emitted only in large quantities by power plants, is a far more straightforward task than limiting carbon dioxide, which is emitted by just about everything. As we watch the Senate take up the climate bill in September, we would do well to ask ourselves if we are building another market that is too complex for anyone to understand.

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