Big Storm Brewing

Climate-Related Disaster Costs in the U.S. Are Enormous and Growing Rapidly

Natural disaster losses in the U.S. currently cost $120 billion annually. For 2024, NOAA is forecasting above-normal activity for hurricanes and storms. Climate-related losses are growing at the alarming rate of six percent per year (National Institute of Building Sciences, 2023). This growth rate is well ahead of the inflation rate, population growth, or GDP growth and its impact on the U.S. economy is unsustainable. The socio-economic impacts of this ballooning societal cost are highly regressive and call for an urgent response.

Are We Staring Down the Barrel of Another Housing Led Financial Crisis?

There are uncomfortable parallels between the current trajectory of climate-related losses and the Great Financial Recession precipitated by the 2007-2008 housing market correction. Back then, ultra-loose lending standards and the re-packaging of risk from originators to unsuspecting holders of ‘highly rated’ mortgage-backed securities allowed a bubble to grow unsustainably until the adjustable-rate mortgage loans with low “teaser rates” reset. This set into motion the asset-markdown spiral across financial institutions. Lending stopped and deteriorating asset values amplified real losses through derivatives such as credit-default swaps. Risk contagion, counterparty default risk and risk of bank runs morphed into a full-blown systemic crisis. The resulting balance-sheet recession was pernicious and required global government interventions on an unprecedented scale.

In loan portfolios underlying mortgage securities the illusion of safety from a number of obligors and geographic diversity was upended by the unexpected correlation of defaults. The 2007-2008 housing crisis demonstrated that a step-change in expectations can induce panic and precipitate a loss of confidence.

Similar to the 2007 phenomenon, we believe that there is a wide and growing deficit between nominal property values and (climate-) risk-adjusted prices. This build-up of risk to the downside may have a hair-trigger release in way of a significant markdown of collateral in the aftermath of an adverse climate event. Climate risk may manifest itself differently across regions, e.g., wildfire, drought, floods, etc., – but the aggregate bottom-line impact will be the same, i.e., a haircut to valuations. Unfortunately, climate risks, both physical and transitional, are under-appreciated by property-owners and they may be under/un-insured due to the retrenchment of alarmed (re)insurers.

Even though the proximate cause of the potential crisis we face due to the impact of adverse climate-related events is dissimilar to the 2007-2008 mortgage crisis, the magnitude may seriously impair or cripple the balance sheets of financial institutions leading to the same outcome. The risk is not just from intensification of pre-existing threats (e.g., hurricanes) but emergence of new risk factors from evolving climate patterns (e.g., shift of Tornado Alley, Heat Dome in the Pacific-Northwest, the stalled Hurricane Harvey over Houston).

Unlike 2007-2008, the potential societal costs of a climate-impact will be much broader than a nominal price adjustment in the housing market. Black and Latino households’ net worth is heavily concentrated in home equity, 63% and 66% (at the median) respectively, and could be disproportionately impacted (PEW Research, 2023) in an adverse climate event. Climate events besides destroying housing stock can also disrupt most sectors of the economy which has a multiplier effect, making a bad situation much worse.

A Call to Action: Building a More Resilient Future for Housing

The challenges are enormous and demand our attention now. The government has made a laudable commitment of $369 billion to clean energy incentives and climate change investments under the aegis of the Inflation Reduction Act, of which $270 billion is for tax incentives and grants that primarily support “Mitigation” with primary focus on initiatives that reduce emission of greenhouse gases to minimize the impact of climate change. “Adaptation”, on the other hand, means anticipating the adverse effects of climate change and taking appropriate action to prevent or minimize the damage they can cause.

Globally, “Mitigation” initiatives account for approximately 91% versus 5% for “Adaptation” actions, of the overall climate change finance flows (Global Landscape for Climate Finance, 2023). Studies estimate that every dollar invested in Climate Resilience can yield up to $15 in financial benefits (USAID, BCG, Global Resilience Partnership, 2023), arguing for investment in our communities now and save on spending on re-build/clean-up in the aftermath. Adequate investments in climate resilience not only push out the tipping point but also invigorate the economy, promote equity, and contribute to the common good. Let us all do our part and make it happen!

In future blog posts, we will address the many challenges, explore solutions, and analyze the successful public-private partnerships in U.S. cities that are leading the way in preparing for a resilient future.