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Taxpayers at risk for U.S. homes threatened by climate change

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  • Banks are selling mortgages on homes in coastal areas around the U.S. that are vulnerable to natural disasters to Fannie Mae and Freddie Mac, a study finds.
  • That could leave taxpayers footing the bill because the two government-sponsored enterprises buy the mortgages without adequately accounting for the heightened property risks.
  • “Climate change could lead to a ‘Big Short’ kind of crisis,” one of the study’s authors said.

The growing threat from natural disasters like hurricanes and floods could leave U.S. taxpayers footing the bill for damage to properties battered by rising seas. The reason: Mortgage lenders — mostly Wall Street banks — are selling loans for homes in vulnerable coastal areas to Fannie Mae and Freddie Mac, according to a working paper released Monday by the National Bureau of Economic Research. 

The two government-sponsored enterprises guarantee those loans against default with taxpayer dollars. That’s creating a “market for lemons” in mortgages and even poses a “a potential threat to the stability of financial institutions,” the authors write. The fallout from climate-change induced disasters could be on par with that of the 2008 financial crisis, they warn. 

“We’re realizing that … climate change could lead to a ‘Big Short’ kind of crisis,” Amine Ouazad, associate professor of economics at HEC Montreal and an author of the study, told CBS MoneyWatch, referring to a 2010 book by Michael Lewis and 2015 film about the housing bubble. 

Ouazad and Matthew Kahn, a professor of economics at Johns Hopkins University, looked at natural disasters between 2002 and 2014 that each caused at least $1 billion worth of damage. Such events increase the chance that homeowners will default on their mortgage or, if they have flood insurance, pay off the mortgage early. The analysis included property data on 18 states along the Gulf Coast, ranging from Texas up the Atlantic seaboard.

Socializing the “worst flood risk”

In the period immediately following 15 hurricanes, lenders issued more mortgages for homes in coastal areas, the study found. Those loans were then “securitized,” or bundled up and sold to other financial entities, including Fannie and Freddie, which are backed by the federal government.

Banks can choose which mortgages to securitize and sell, but Fannie and Freddie are essentially required to buy any mortgages that meet certain criteria. But the firms are purchasing those loans without factoring in the property risks due to climate change. That allows “commercial lenders to transfer their worst flood risk” to Fannie and Freddie with “no negative market signals,” according to the study. 

A climate reckoning in the heartland

Banks pay a so-called guarantee fee when they sell bundled mortgages, but it doesn’t account for climate-related risks. That means that Fannie and Freddie are subsidizing mortgages in flood-prone areas. 

“Banks are using capital markets to shift risks from their books to Fannie Mae and Freddie Mac,” said Jesse Keenan, a social scientist at Harvard University who studies urban development and climate adaptation who wasn’t involved in the study. “They don’t want to have the risk on their books when they can absolve themselves, not entirely but largely. It’s what we call socializing the risk.”

“The markets in these areas would probably dry up if you charged the true cost of these mortgages,” he added.

In a statement, a Freddie Mac spokesperson said the GSE “takes a number of steps to manage our flood risk, including requiring flood insurance on properties located in Special Flood Hazard Areas as designated by FEMA.” Fannie Mae didn’t respond to a request for comment.

The researchers don’t name specific banks, but Ouazad noted that more of the activity was coming from national banks than from nonbank lenders (such as Quicken or Rocket Mortgage, though no non-bank is named in the paper, either.) The impact isn’t limited to a single bank, Ouazad said; rather, “It is actually the behavior of large, FDIC-insured national banks.”

Mortgage lenders issue about $1.8 trillion of new debt every year, and Fannie and Freddie currently have a combined $5.5 trillion worth of mortgages on their books. A report from the Union of Concerned Scientists issued last year found that more than 300,000 homes are at risk of being chronically flooded by 2049 — within the lifetime of a typical 30-year mortgage issued today.

Residents on Louisiana island may lose homes to climate change

The Trump administration has proposed privatizing Fannie and Freddie, which were bailed out after nearly collapsing during the 2008 financial crisis. On Monday, the White House took the first steps toward that goal, which if completed would eventually reduce the risk for taxpayers. 

However, private investors are likely to demand a much higher return for backing disaster-prone mortgages, Keenan suggested. That would likely curtail lending for such homes and potentially slam real estate prices in areas threatened by global warming.

“Once the mortgage market starts to fully price in climate change, it may strain a lot of assets — families may not be able to sell their houses, or they may not be able to sell them for nearly as much as they want,” Keenan said.

“This could really trap a lot of people in their homes, and as a matter of policy we need to unwind that.”

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