Climate and Coastal Flooding Will “Blow a hole” in Mortgages

November 11, 2019

CBS News:

Climate change could punch a hole through the financial system by making 30-year home mortgages — the lifeblood of the American housing market — effectively unobtainable in entire regions across parts of the U.S.

That’s what the future could look like without policy to address climate change, according to the latest research from the Federal Reserve Bank of San Francisco. The bank is considering these and other risks on Friday in an unprecedented conference on the economics of climate change.

For the financial sector, adapting to climate change isn’t just an issue of improving their market share. “It is a function of where there will be a market at all,” wrote Jesse Keenan, a scholar who studies climate adaptation, in the Fed’s introduction.

The housing market doesn’t yet factor in the risk of climate change, which is already affecting many areas of the U.S., including flood-prone coastal communities, agricultural regions and parts of the country vulnerable to wildfires. In California, for instance, 50,000 homeowners can’t get property or casualty insurance because of the increased risk to their homes.

Yet for now, no mortgage lender, portfolio manager or buyer of mortgages takes into account climate-induced floods, except to determine if a house sits in a 100-year floodplain at the time the mortgage is issued, said Michael Berman, a former official with the U.S. Department of Housing and Urban Development and former chairman of the Mortgage Bankers Association.

Once lenders and housing investors do start pricing in such risks, “There may be a threat to the availability of the 30-year mortgage in various vulnerable and highly exposed areas,” Berman wrote in a recent San Francisco Fed report. He predicts lenders could “blue-line” entire regions where flood risks are high — a reference to redlining, the practice of refusing mortgages to minorities.

The result: Entire neighborhoods would empty out, leaving cities unable to shore up their crumbling roads and bridges just as severe weather events become more extreme and more frequent. Home values would fall, potentially depleting the budgets of counties and states.

For most people, being unable to get a mortgage in a given neighborhood would rule it out as a place to live. But population flight is a best-case scenario when it comes to the financial system.

If banks don’t recognize the danger of flood risk and keep lending only to have flooded homeowners default on their mortgages, the events could lead to a cascade of negative events akin to the housing collapse in 2008, which set off the worst recession in 70 years.

“Nobody denies that [climate change] is happening, that it’s real, that it is going to have a material effect. But by and large, there is such an inertia in our financial system that this isn’t even on the radar of people,” said Rachel Cleetus, policy director for the climate and energy program at the Union of Concerned Scientists (UCS). “The market is short-sighted. You have a three- to five-year horizon.”


Some banks are cutting their own climate-change exposure by selling riskier disaster-area mortgages to taxpayer-supported entities.

That puts the health of the mortgage market at risk, a potential repeat of the financial conditions at the root of the banking crisis a decade ago, a research paper published in September argues.


The number and total value of flood insurance policies has been declining since 2006, meaning that households that purchased a property in coastal areas especially may be at increased risk of defaulting on their mortgages, the academic paper said. Commercial banks, including two of the largest U.S. mortgage lenders, JPMorgan Chase JPM, -0.59% and Wells Fargo WFC, -0.59%  , have the ability to price mortgages for flood risk, and by design they can securitize some of these loans, thereby spreading the risk to more parties.

But one of the more active ways banks unload climate-change and flooding risk is by reselling mortgage loans to Fannie Mae FNMA, -0.97% and Freddie MacFMCC, -0.69% , which desire the liquidity, the paper says. These entities are the mortgage guarantors that are under tax-supported government control, though have been tagged by the Trump administration for a shift to the private sector. By rule, primarily because their mission is to expand homeownership, Fannie and Freddie cannot factor disaster-related risk, for instance living in a flood zone, into their mortgage pricing in the way that the commercial banks originating these loans can.

Absent change, the mispricing is only going to be aggravated, the paper notes, with $60 billion to $100 billion in new mortgages issued for coastal homes each year.

The researchers, Amine Ouazad, a professor in the department of applied economics at HEC Montreal, and Matthew Kahn, a professor at Johns Hopkins University, say their findings show “a potential threat to the stability of financial institutions.”

That harkens back to the start of the subprime lending crisis of 2008. On the plus side, the number of climate-change-linked mortgages is believed to be smaller than the pool of risky subprime mortgages that tainted the system 10 years ago. On the other hand, damaged properties could be lost forever to flooding, wind and storm surges, meaning there’s no underlying physical asset behind these compromised mortgages.

Freddie Mac’s then–chief economist Sean Becketti in 2016 wrote that “the economic losses and social disruption [of rising seas on coastal housing] may happen gradually, but they are likely to be greater in total than those experienced in the housing crisis and Great Recession.”

It is, he wrote at the time, “less likely that borrowers will continue to make mortgage payments if their homes are literally underwater.”



Consider how most home purchases are arranged with long-term mortgages. While the conditions vary, a buyer of a $400,000 home may arrange a 5% fixed-rate, 30-year mortgage on $320,000, and agree to pay it back by making 360 monthly payments of about $1,700. If the lender holds this loan on its balance sheet, and climate change creates new expenses — from flooding, storms or wildfires — the borrower becomes more likely to default on the loan.

Consider that lenders originate an estimated $60-100 billion in mortgages on coastal properties, and it’s clear the potential aggregate impact of default due to climate change is significant.

Lenders can lower their risk, however, by exercising their option to sell loans to Fannie Mae and Freddie Mac, the government-sponsored enterprises that were created by Congress to improve access to mortgage lending. Fannie and Freddie have an important public mission, but lenders’ ability to sell them mortgages means that the risk of climate-related real estate expenses is easily relayed from homebuyers to taxpayers.

To gain some insight into the scope of this problem, we examined what happened in mortgage markets after 15 “billion-dollar” disasters, including Hurricanes Katrina ($119 billion) and Sandy ($73 billion). We found that natural disasters significantly raise the number of delinquencies, defaults and foreclosures. This is probably a consequence of the decline in flood insurance: When fewer homes are insured, less of the damage from storm surges and the like is repaired. Fewer homes are rebuilt. And many more homeowners default on their loans.

These mortgage defaults and payment delinquencies affect both lenders and Fannie Mae and Freddie Mac. In areas where natural disasters hit, we found, bank lenders transfer substantially more mortgages to the government-supported enterprises. And this increase is largest in neighborhoods where floods are “new news” — that is, where flooding has only recently become a regular occurrence. Indeed, lenders quickly learn where not to hold loans in their portfolios.

The existing rules of the mortgage-lending game actually maximize this risk to taxpayers, as Fannie and Freddie’s guarantee becomes a substitute for flood insurance. Simple reforms could discourage lenders from leaning so hard on the government-supported enterprises to absorb climate risks. The securitization fees (also called guarantee fees) that Fannie Mae and Freddie Mac charge lenders to take on their loans should be higher for properties at relatively high risk of flooding. And the fee structure should be designed to shift along with changes in risk and improvements in forecasting, as new climate-change scenarios materialize.



5 Responses to “Climate and Coastal Flooding Will “Blow a hole” in Mortgages”

  1. jimbills Says:

    That would be an interesting scenario – entire neighborhoods abandoned in advance of future catastrophes either by fire or flood. In its way, that’s actually a good thing – if a place is to become unlivable, it’s better that the people are gone from it before it becomes so.

    The debt default scenario here requires a lot of people living in these at risk homes during an event. We’ve had the Californian wildfires and Houston floods, though, without a blip. It’s not to say a debt default crash from flooding or fires couldn’t happen, but it would require either a major event or an economy that was already particularly brittle.

    The big news here, though, is the Fed even holding a conference about climate change and making statements about the issue in the first place:

    This is news in that they’ve been very, very silent about climate change in the past.

    ‘“[T]he consequences of higher temperatures on the U.S. economy may be more widespread than previously thought,” the authors wrote.’

    That’s like the Fed saying, “Our bad.”

    • jimbills Says:


      “But those threats force the central bank, which prizes its political independence, to walk a tightrope. The Fed could be criticized for weighing in on a highly politicized issue: Survey data suggest that Democrats tend to be much more concerned with climate than Republicans.

      Against that backdrop, United States monetary policymakers have been slow to create a concerted climate change research program, even as peers like the Bank of England began to talk frequently about the economics of global warming.

      This week brought a significant shift in that approach. The Federal Reserve Bank of San Francisco, one of 12 regional branches, held the system’s first-ever climate research conference. It is partly a sign that the central bank is ready to talk about a global economic agenda item — and partly a recognition that the risks are too important for the authorities to ignore.”

    • rhymeswithgoalie Says:

      That would be an interesting scenario – entire neighborhoods abandoned in advance of future catastrophes either by fire or flood. In its way, that’s actually a good thing – if a place is to become unlivable, it’s better that the people are gone from it before it becomes so.

      Aye, but many such neighborhoods—being generally better than tin shacks—are going to become defacto settlements for a lot of the poor and their predators. They will be the Marsh Harbors of future fires and storms.

      • jimbills Says:

        True, if the affordable housing issue isn’t addressed adequately, then that likely would happen.

        If, though, an area becomes so tax revenue poor, all the infrastructure would fail, and even the poor wouldn’t be too keen on living in a place without water, electricity, and roads and with fires or floods. Or the state or federal government could create an off-limits area if it just becomes a bandit haven.

        Who knows, really – an interesting thought to ponder for now, though.

        • rhymeswithgoalie Says:

          My sister moved back to New Orleans to camp out for a couple of months at our parents’ house until it could be rehabilitated. She cooked on a hibachi on the porch, got a small generator for her limited electricity needs, and drove to the Isle of Denial for supplies.

          Until the sewers are at last allowed to fail, people can make do.

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