Banks Quietly Moving Flood Risk to Taxpayers

September 27, 2019

New York Times:

Banks are shielding themselves from climate change at taxpayers’ expense by shifting riskier mortgages — such as those in coastal areas — off their books and over to the federal government, new research suggests.

The findings echo the subprime lending crisis of 2008, when unexpected drops in home values cascaded through the economy and triggered recession. One difference this time is that those values would be less likely to rebound, because many of the homes literally would be underwater.

In a paper to be released Monday, the researchers say their findings show “a potential threat to the stability of financial institutions.” They warn that the threat will grow as global warming leads to more frequent and more severe disasters, forcing more loans to go into default as homeowners cannot or would not make mortgage payments.

“We’re talking about a loss that’s going to be borne by United States taxpayers,” said Amine Ouazad, a professor in the department of applied economics at HEC Montreal and one of the paper’s authors. He added that with between $60 billion to $100 billion in new mortgages issued for coastal homes each year, “we’re not talking about a small number.”

Mr. Ouazad, along with his co-author Matthew Kahn, a professor at Johns Hopkins University, examined the behavior of mortgage lenders in areas hit by hurricanes between 2004 and 2012, each of which caused at least $1 billion in damages. They found that, after those hurricanes, lenders increased by almost 10 percent the share of those mortgages that they sold to Fannie Mae and Freddie Mac, government-sponsored enterprises whose debts are backed by taxpayers. 

Selling mortgages to Fannie and Freddie allows banks to avoid the financial risk that homeowners will default on the mortgages. Hurricanes increase that risk: Mr. Ouazad and Mr. Kahn found that the odds of an eventual foreclosure rise by 3.6 percentage points for a mortgage originated in the first year after a hurricane, and by 4.9 percentage points for a mortgage originated in the third year.

The regulations governing Fannie and Freddie do not let them factor the added risk from natural disasters into their pricing, which means banks and other lenders can offload mortgages in vulnerable areas without financial penalty. That increases the incentive for banks to make the loans and then move them off their books, the authors said.

Fannie Mae and Freddie Mac are private companies created by the government to support mortgage and housing markets. After suffering massive losses during the 2008 financial crisis, the federal government essentially began to back their debts. The Trump administration has proposed shifting their role to the private sector, though no legislation appears imminent.

Mr. Ouazad said he and Mr. Kahn looked at data for thousands of lenders, and their findings reflect the average of those lenders’ behavior after hurricanes. He declined to share the findings about any specific lender, while saying that the increase in securitization was greater for national banks.

When asked about the findings, representatives of JP Morgan Chase and Wells Fargo, two of the country’s largest mortgage lenders, denied engaging in the practice described in the paper. Quicken Loans and Bank of America did not respond to questions.

The Mortgage Bankers Association, which represents mortgage lenders, declined to comment. The Federal Housing Finance Agency, which sets the rules governing the behavior of Fannie and Freddie, did not respond to a request for comment.

Fannie Mae and Freddie Mac declined to comment on the paper or to describe what share of the mortgages they hold are for homes in flood zones.

Housing economists who were not involved in the research said that the methodology used by Mr. Ouazad and Mr. Kahn was sound, and that their findings would raise troubling questions about who will bear the financial cost of climate change in the United States.

“The problem they’ve discovered is likely to grow in magnitude and is clearly important, because the taxpayer is on the hook,” Susan Wachter, a professor of real estate and finance at the University of Pennsylvania’s Wharton School, said. The mortgage market’s exposure to flooding “could be as large as the losses due to the subprime crisis,” Ms. Wachter said, referring to the 2008 housing crisis, which threw the nation into its worst economic downturn since the 1930s.

The paper’s findings suggest that banks and other lenders are aware of that threat, she added. “They see this coming,” Ms. Wachter said. “And they’re taking steps to shift the risk.”

Christopher Flavelle on Twitter:

First, it indicates that banks are aware of the risk that natural disasters pose. So this is the latest example of the market acting while governments argue about the science.

Second, this offers a glimpse into *how* climate risks are likely to ripple through the market: The most sophisticated, best-informed actors will move first, before regulators realize what’s happening or have time to respond.

Third, this data shows how well-intentioned policies can get in the way of adaptation — in this case, by making mortgages cheaper in vulnerable areas, reducing the incentive for community-scale mitigation or just moving.

And that’s the hardest question: How do you insulate people from the full (and in some cases unbearable) cost of what’s coming, without blinding them to that risk? Climate adaptation is fundamentally a debate about what’s fair, and we’ve barely begun to grapple with it.

One Response to “Banks Quietly Moving Flood Risk to Taxpayers”

  1. Sean Munger Says:

    Fascinating, and entirely predictable to people who have been trying to project how the business world is dealing with climate change. When engaging in the pointless exercise of arguing with deniers, evidence like this should be used every bit as much as scientific material. Because this practice alone proves that climate change is happening and is of immense financial magnitude. I try not to argue with deniers at all, but those who do should take note of this.


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