Bob Litterman spent a career looking for trouble: trouble in markets, trouble in businesses, trouble of the sort that could send the world economy spiraling into crisis. A former head of Goldman Sachs' risk department and MIT economics professor, Litterman retired late last year, and today in New York he told a high-level investors' gathering that the global economy is barreling toward a crisis on par with the subprime mortgage meltdown, all thanks to free carbon emissions.

In a speech to sovereign wealth fund managers, Litterman, now a board member of the World Wildlife Fund, argued that markets are dramatically underestimating the threats of climate change, underpricing emissions, and risking dramatic and dangerous shocks when companies are eventually forced to adjust.

Just as investors didn't account for the true risks of subprime defaults, Litterman says, markets aren't adjusting for the chances that climate change will soon devastate ecosystems and reshape lifestyles. If they were, the carbon emissions that scientists blame for warming temperatures would carry some additional cost, a risk premium for potential future climate effects.

''That uncertainty is what we have to price,'' Litterman said in an interview. ''That's the lesson of subprime mortgages: If you don't price risks, you take too much of it. Think about the price of emissions as a bike [heading downhill]. We're going too fast here. Let's get back in control.''

Litterman suspects that eventually, markets will recognize the need for a carbon price. He thinks that recognition is more likely to come abruptly than gradually, perhaps sparked by extreme weather events. The longer it takes for the world to impose carbon prices, the more abrupt the price shock will be.

With a few exceptions, governments have shown little willingness to tax fossil fuel emissions, either directly or through carbon-trading systems. In the United States, a growing number of lawmakers and candidates have adopted the belief that manmade climate change does not exist, a view that Litterman calls ''insane.'' ''How can you be 100 percent sure?'' he asks. ''The right question is, What's the probability?''

Which is why Litterman took his pitch to sovereign wealth funds, which invest on time horizons far beyond standard election or business cycles. In his speech, he urged the managers to shift ''toward investments that will benefit from emissions being priced, and away from investments that will be adversely affected when carbon is priced.''

It's not a question of ethics or environmentalism, he says. ''I'm saying, this is where prices are going'' - and what trouble might lurk nearby.

More in Energy Go to section

October 04, 2010 | Energy and Environment Bulletin

Is Unpriced Carbon The Next Subprime?

September 02, 2010 | Energy and Environment Bulletin

Dems Seek Answers On Gulf Explosion

September 01, 2010 | Energy and Environment Bulletin

BP Spent Big On Advertising After Spill

August 24, 2010 | Tech Daily Dose

Biden: Stimulus Dollars Fueling Energy and Life-Saving Technology

August 17, 2010 | Insider Interviews

Deepwater Horizon's Enduring Lessons