Harvard Business Review: Are We On the Verge of Another Financial Crisis?

[PDXTabs]

I found this interesting article this morning. I have highlighted a couple of sections here, the whole article is linked below.

John Macomber, a senior lecturer in the finance unit at Harvard Business School, believes we may be on the verge of a collapse in housing prices and an ensuing financial crisis — this time caused by our failure to acknowledge and confront climate change...

Among other issues, we haven’t faced the tough question of whether people should be restricted from building or rebuilding in these places that are, in the example of California, natural fire corridors that have been recognized for centuries.  Instead, in California we’ve required utilities to bring power to homes in these dangerous areas, and now the state is mandating that insurance companies renew fire policies at below-market rates.  Similarly, in parts of the east coast, private insurers have long since exited the homeowner flood risk market and instead the coverage is provided with deeply subsidized premiums by state agencies relying on the National Flood Insurance Program.

In the end though, I expect there will be certain areas in the country (and in the world) where people just can no longer live, as a result of drought, sea rise, wildfire, or flood. This realignment has the potential to be very unfair to people with poor access to capital and poor access to information (while beneficial to those with capital and data). It also has the potential to be forward looking, well-managed, and fair.  The sooner we confront this reality the less painful, and more equitable, the correction will be.

Are We On the Verge of Another Financial Crisis?

[FINate]

Much of his analysis is solid, though I disagree that this necessarily means we are on the verge of another financial crisis.

Housing prices along the coast and in the WUI should adjust down as the full effects of climate change, bad forest management, and poor urban planning become more apparent. We don't need to "restrict" building in these areas via regulation if we let insurance premiums accurately reflect the true risk. To some extent this is already underway, have heard from acquaintances in CA experiencing 2-3x increases in fire premiums with many falling back on the so-called FAIR Plan (state sanctioned insurance of last resort).

Nor do I think we should try to smooth this adjustment out, as the author proposes, over 10 years. This is just another way of saying we should give affluent people an opportunity to be bailed out by less affluent low-information buyers who will be left holding the bag. I say this as a homeowner with other RE investments: We need to let the housing market take its lumps and stop intervening to ensure housing only ever increases in value, which is how we'll sow the seeds of the next speculative crash.

Coastal communities should plan for a managed retreat along the seashore and refuse to subsidize wealthy ocean front homeowners by paying for expensive (and environmentally ruinous) seawalls. Rural communities should prioritize fire safety and forest thinning within/near town limits. Homeowners in the WUI should plan for much higher premiums, and accept that either their property is likely to burn within about decade or build fire-hardened structures on defensible lots.

We are not in a situation of systemic overbuilding and rampant speculation as in 2008-2009. If anything, we're experiencing a nationwide housing shortage. So while properties devalue in areas most affected by climate change, this will push up demand and prices in other areas. We already have precedent for this type of housing realignment from the 1970s and 1980s with white flight to the 'burbs. Obviously this wasn't a good thing, and it was racially driven and terribly inequitable, but it didn't trigger a financial crisis.

So how do we adapt to a housing market shaped by climate change?  IMO, the first priority should be building way more housing in those urban areas where fires and coastal flooding/erosion are less problematic. Things like dense infill, improved mass transit and bike commute infrastructure. The key is affordability by design to accommodate those that finally throw in the towel with their forested rural and oceanfront homes.

[PDXTabs]

Coastal communities should plan for a managed retreat along the seashore and refuse to subsidize wealthy ocean front homeowners by paying for expensive (and environmentally ruinous) seawalls. Rural communities should prioritize fire safety and forest thinning within/near town limits. Homeowners in the WUI should plan for much higher premiums, and accept that either their property is likely to burn within about decade or build fire-hardened structures on defensible lots.

Along those lines, you should read The Control of Nature by John McPhee, originally published in 1990. But do you really think that we can turn off power to a bunch of rural communities in California or let them flood in the Mississippi river delta without incredible human and political costs?

EDITed to add that cities have been subsidizing rural electrical infrastructure for almost as long as there has been electricity. Obviously this has huge economic costs in the short term but in the long term has probably paid off. Choosing where to draw the line seem very tricky.
https://livingnewdeal.org/glossary/rural-electrification-administration-rea-1935/

[FINate]

Along those lines, you should read The Control of Nature by John McPhee, originally published in 1990. But do you really think that we can turn off power to a bunch of rural communities in California or let them flood in the Mississippi river delta without incredible human and political costs?

EDITed to add that cities have been subsidizing rural electrical infrastructure for almost as long as there has been electricity. Obviously this has huge economic costs in the short term but in the long term has probably paid off. Choosing where to draw the line seem very tricky.
https://livingnewdeal.org/glossary/rural-electrification-administration-rea-1935/

Well now, we don't need to turn off power to rural communities. I'm fine with a certain amount of subsidy for public good, would even say it's necessary to a degree, though to what degree is a policy question that I don't have a strong opinion on. But that's different than subsidizing homeowners for fire insurance to enable them to keep living in an unsustainable location, which is a benefit going almost exclusively to the homeowner and not the general public.  Whereas things like power transmission and roads are more of a public good.

RE the flooding issue: It's going to happen unless many many billions of dollars are invested in new flood control, and then it will probably still happen regardless. Where do we draw the line, how much do we invest to protect low-lying housing and farmland, and when do we cut our losses and expect people to move to someplace more reasonable? In other words, it's not as if we "let it" flood as much as decide it's not cost effective, come what may.

[PDXTabs]

RE the flooding issue: It's going to happen unless many many billions of dollars are invested in new flood control, and then it will probably still happen regardless. Where do we draw the line, how much do we invest to protect low-lying housing and farmland, and when do we cut our losses and expect people to move to someplace more reasonable? In other words, it's not as if we "let it" flood as much as decide it's not cost effective, come what may.

Yes, but we've been spending billions keeping the Mississippi in its banks for longer than I have been alive. You are correct that one day it will jump those banks and hurt low-lying housing, but it might actually help farmland. The reason that the topsoil in that part of the country was so rich when we found it was from periodic flooding from the Mississippi. By controlling the river, in the long run, we are hurting the farmland. I personally would let it flood, but try convincing congress.

[FINate]

Yes, but we've been spending billions keeping the Mississippi in its banks for longer than I have been alive. You are correct that one day it will jump those banks and hurt low-lying housing, but it might actually help farmland. The reason that the topsoil in that part of the country was so rich when we found it was from periodic flooding from the Mississippi. By controlling the river, in the long run, we are hurting the farmland. I personally would let it flood, but try convincing congress.

True, though nowadays things may not be as simple for farmland due to the pollution found in most flood waters.

[Hotstreak]

RE the flooding issue: It's going to happen unless many many billions of dollars are invested in new flood control, and then it will probably still happen regardless. Where do we draw the line, how much do we invest to protect low-lying housing and farmland, and when do we cut our losses and expect people to move to someplace more reasonable? In other words, it's not as if we "let it" flood as much as decide it's not cost effective, come what may.

Yes, but we've been spending billions keeping the Mississippi in its banks for longer than I have been alive. You are correct that one day it will jump those banks and hurt low-lying housing, but it might actually help farmland. The reason that the topsoil in that part of the country was so rich when we found it was from periodic flooding from the Mississippi. By controlling the river, in the long run, we are hurting the farmland. I personally would let it flood, but try convincing congress.

Federally subsidized flood insurance is a disaster.  The entire country should not be paying for the losses of the low lying areas, which are predictable and routine.  Disbanding  the national flood insurance program would result in a generational movement of people away from climate affected areas and towards less flood prone areas.  This sort of change relies on basic principles of natural consequences and self reliance which have been lost.  I don't see how any of this gains popular support without a major national catastrophe.

[maizefolk]

I completely agree federal subsidies for flood insurance are a disaster. If we're going to subsidize people's risk, we could at least use the subsidy money to pay people to relocate when their houses do get wiped out instead of only paying to rebuild at the original location. I don't think we are on the edge of another financial crisis. But the minute banks start refusing to write 30 year mortgages on houses in coastal Florida* I do think it'll set off a big and sudden local drop in property values. It's just a question of who will be left holding the bag when that happens.

I completely agree federal subsidies for flood insurance are a disaster. If we're going to subsidize people's risk, we could at least use the subsidy money to pay people to relocate when their houses do get wiped out instead of only paying to rebuild at the original location.

The Mississippi jumps its banks pretty regularly and wipes out nearby towns. But the great farmland in the midwest is more credit to thousands of years of prairie living and dying and building up soil organic matter in an outstanding matrix of finely ground rock powder created by glaciers running back and forth over the region. The rice growing regions of Arkansas do owe a lot of credit to the shifting/flooding channel of the Mississippi, though.

*Probably will happen first for jumbo mortgages that cannot be resold to Fannie Mae/Freddie Mac.

[Hotstreak]

The practice of refusing to underwrite mortgages in specific neighborhoods is called "redlining".  It is illegal, due to the history of banks refusing to lend to historically poor/black neighborhoods.  Banks can't stop lending to coastal towns under the current framework.  If fed gov stops backstopping flood insurance, and properties are denied insurance, that should be enough of a "non-racist" reason to stop lending.

[maizefolk]

My understanding of the fair housing act is that it only prohibits refusing to lend in neighborhoods on the basis of racial composition, but banks are still allowed to decide to lend or not lend based on other factors like differences in the risk of different natural disasters. So something like "we're not going to lend on houses within five feet of sea level anywhere in Florida" would pass legal muster.

It sounds like you're hearing it described otherwise though?

[PDXTabs]

*Probably will happen first for jumbo mortgages that cannot be resold to Fannie Mae/Freddie Mac.

But that's kind of the whole point of the article. Banks are going to keep lending as long as they can re-sell the mortgages and insurance companies are going to keep selling policies as long as they can find re-insurance companies to hold the bag. Which sounds an awful lot like the 2007/8 financial crisis.

[maizefolk]

Yes, which is why I think jumbo mortgages are going to be the first crack in the wall which brings the whole thing down (although I think "the whole thing" is much MUCH smaller than '08/'09). For regular mortgages, banks can get insurance/guarantees from Fannie/Freddie, so they don't have to do nearly as much due diligence. The risk is shifted off their books to the GSEs and ultimately to us the taxpayers.

For a jumbo mortgage, the people who ultimately purchase the loan don't have that guarantee and they have to put more consideration into the risks involved over a 30 year payback period, which is why those mortgages tend to require more documentation and lower loan to value ratios. If 16 years from now there is a decision made to end federal subsidies for flood insurance (a lot can happen in four presidential elections and eight congressional elections) and, 17 years from now, the mansion someone took out a mortgage on is wiped out, the person who bought the jumbo mortgage, or the private sector guaranteer if there is one, could end up with a very big loss.

I don't know if the GSEs even could start considering geographic factors in which mortgages they will or won't buy or guarantee, but even if they could, they have a big incentive not to alienate a bunch of people on the coasts of populous states by making their homes harder to resell and worth less. Best not to poke the sleeping bear of congress (which ultimately backstops the GSEs and makes their business model possible). Private sector banks/investors behind jumbo loans also don't have to worry about political consequences to the same extent if they decide that survival/insurability/resaleability of houses certain parts of the country are too uncertain to treat those houses as collateral for a loan that won't be paid off until the second half of the 21st century.

*And unlike the 2008/9 crash, because the losses wouldn't hit the whole economy at once, there would be less likelihood the federal government steps in to bail things out, so moral hazard isn't at play to the same extent.

[fuzzy math]

The Mississippi jumps its banks pretty regularly and wipes out nearby towns. But the great farmland in the midwest is more credit to thousands of years of prairie living and dying and building up soil organic matter in an outstanding matrix of finely ground rock powder created by glaciers running back and forth over the region. The rice growing regions of Arkansas do owe a lot of credit to the shifting/flooding channel of the Mississippi, though.

The Missouri river did not have a traditional riverbed and moved many times over the years. People trained it to have the path it has today, but when it floods it still seeks out those historic other paths.

[PDXTabs]

The Mississippi jumps its banks pretty regularly and wipes out nearby towns. But the great farmland in the midwest is more credit to thousands of years of prairie living and dying and building up soil organic matter in an outstanding matrix of finely ground rock powder created by glaciers running back and forth over the region. The rice growing regions of Arkansas do owe a lot of credit to the shifting/flooding channel of the Mississippi, though.

The Missouri river did not have a traditional riverbed and moved many times over the years. People trained it to have the path it has today, but when it floods it still seeks out those historic other paths.

Yes, in nature it would continue to move about. About a quarter of The Control of Nature is dedicated to the Mississippi.

[uniwelder]

Would there be interest in moving this (or cross-posting or linking if possible, I don't know the forum setup well) to the 'real estate and landlording' section?  In my short time participating here, I feel like I'm the lone voice against beach houses when its been brought up by those who follow allow with real estate.  You'd probably get more exposure and some different viewpoints regarding the topic.

[PDXTabs]

Would there be interest in moving this (or cross-posting or linking if possible, I don't know the forum setup well) to the 'real estate and landlording' section?  In my short time participating here, I feel like I'm the lone voice against beach houses when its been brought up by those who follow allow with real estate.  You'd probably get more exposure and some different viewpoints regarding the topic.

I'm fine with that, but the last time I posted anything like this in the General discussion a mod moved it to Off Topic. ¯\_(ツ)_/¯

[Glenstache]

A very real issue with public zoning designations, hazard area designations and the like is that regulating governmental agencies are often damned if they do and damned if they don't. If agencies change the zoning or designation of an area to prevent building, or substantially change codes to respond to natural hazards they are often sued by land owners for having decreased the value of their property under the argument that it is a taking (yes, this happens and happens often). However, if they do not apply those zoning or hazard designation and then the thing happens, they are sued for negligence and "why didn't you tell us this bad thing would happen?" These suits are often incredibly expensive.

It is also naive to think that removing the flood insurance programs will result in a mass migration out of those areas. What we will see is that the property values will change and that poor people will end up living there because they can afford it, and they will be disproportionately affected by the floods. There are a lot of problems with the national flood insurance and I think that payments should be tied to future zoning restrictions and changes in code to address flooding. This type of approach has been applied successfully in many areas (2 story houses with flood-friendly first floors do a lot to reduce impacts).

As a practical matter, insurance companies are already pricing the cost of climate change into their calculations.
Random example: https://www.uphelp.org/north-bay-residents-face-new-risk-after-wildfires-insurers-dropping-their-homeowner-policies

Climate change impacts are going to have a lot of destruction and rebuilding associated with it. Given that there is a fixed building lifespan for a lot of structures, at least some of the economic and human cost can be bunted through smart, forward-looking zoning, infrastructure and financial programs. There is a huge financial (and worse) risk to not planning for the very real effects of climate change.

[uniwelder]

Posting to get this thread bumped to the top....

I had asked to get it moved from "off topic" to this section, hoping the real estate browsing members would have some input.

[Jon Bon]

It is also naive to think that removing the flood insurance programs will result in a mass migration out of those areas. What we will see is that the property values will change and that poor people will end up living there because they can afford it, and they will be disproportionately affected by the floods. There are a lot of problems with the national flood insurance and I think that payments should be tied to future zoning restrictions and changes in code to address flooding. This type of approach has been applied successfully in many areas (2 story houses with flood-friendly first floors do a lot to reduce impacts).

I just think it will require a level of self insurance and some kick ass buildings. A building made out of concrete is probably going to weather a hurricane just fine. Rich people are always going to want to live on the ocean*, it is just going to (rightly) cost them a little more, and the public wont bear cost of them rebuilding their homes. Make the houses twice as expensive to build (better materials/methods) and I think that would go a long way.

So I agree that government flood insurance is not a good idea, we need to allow the market to work here. Phase is out over time, this stuff does not need to be done overnight. I don't think the Florida coast is going to be taken over by poor people because that is the cheapest place they can live.

*I have no idea who is covered by federal flood insurance, maybe it already does not cover the seaside mansions and does cover the middle class homes 15 miles inland, if that is the case my answer would likely change.

[uniwelder]

I thought I'd add to the current posting rather than create a new one----

Here's an article I just read this morning on NPR--- https://www.npr.org/2021/02/22/966428165/a-looming-disaster-new-data-reveal-where-flood-damage-is-an-existential-threat

FEMA plans to begin raising flood insurance rates in October to finally match the cost of structure replacement and limit its $36 billion debt.  The new program is called Risk Rating 2.0.  Increases would be as much as 18% per year until they reflect the actual risk adjusted cost.  It was said that some areas currently pay only 4% of the fair amount, so it looks like some wealthy people may be charged up to 25x more.  The highest increases would be paid by the wealthy because the current system disproportionately discounts their expensive homes.