It was an eye-popping headline in the New York Times earlier this summer – “Rising Seas Threaten an American Institution: The 30-Year Mortgage.” The somewhat less-explosive point was that in an effort to avoid risks of climate change-caused defaults on mortgages – especially involving homes facing sea-level rise and increased flooding – banks have been selling off those mortgages.

And they’ve been selling them off to you and me.

More specifically, they’ve been selling them to Fannie Mae and Freddie Mac, the two big government-created private lenders that handle more than half the U.S. mortgage market. But it’s taxpayers who pick up the tab for Fannie and Freddie’s debts – like defaults if sea-level rise makes a home unlivable and the owner stops paying the mortgage.

This mortgage offloading has been chronicled over the past year or so in a few academic and think tank reports, largely noted by the wonk crowd and the New York Times, which also wrote a story about it last September based on an earlier, but similar report. That piece carried a more subdued headline – “Climate Risk in the Housing Market Has Echoes of Subprime Crisis, Study Finds.”

Spreading the misery of concentrated risk liability

But the interesting thing is that economists aware of what’s been happening typically are saying: good move by those small banks. They’re getting rid of the risk and getting it into the hands of big financial institutions that can absorb it by spreading it around their pool of mortgages. In that way, the good ones can balance out the bad.

“The problem with smaller banks is that all of their customers are geographically concentrated,” says Gary Yohe, an environmental economist, recently retired from Wesleyan University. “A storm comes and all of those properties are going to be problematic.”

“It’s a good thing for banks. They’re being smarter about it.”

It comes down to this: A lot of entities involved in the housing and mortgage markets are doing risk management for themselves in the face of climate change, says Carolyn Kousky, executive director of the Wharton Risk Management Center at the University of Pennsylvania. “That’s good for the lender, but that doesn’t mean it’s sending the right signals down at the household level.”

Of course, if Frannie and Freddie get enough bad mortgages, the pain will start to be apparent to the taxpayers left holding the bag. That begs the enormous question of what can be done with the mortgage system so it reflects climate change risk.

Stand warned: as soon as things reach for that simplest of answers – higher mortgage rates, shorter terms, and/or more cash up front for at-risk properties – a gazillion red flags go up, most of them with “equity” written on them.

“If you put more of the cost of risk on the individual landowner, which would help them make better decisions and presumably discourage development in the riskiest areas and encourage safer development,” Kousky says, “you’re also contributing to a big inequality problem at the coast.”

Lower-income people will be pushed out, and then the shoreline increasingly becomes something only the very affluent can afford.

Equity versus efficiency

That’s how Benjamin Keys states the fundamental problem in figuring out how to re-imagine a mortgage system that accounts for climate change, especially along the coasts. He is an associate professor of real estate and finance, also at Wharton, and a faculty fellow at the Risk Center that Kousky directs.

His research involves how households make financial decisions especially related to mortgages, and he also focuses on risk-based pricing.

“The market signals that we’re getting about coastal property markets, those are telling us something really important,” he says.

Keys points out that the risks are known and modeled very carefully to show which places are riskier than others. The issue, he says, is whether prices of mortgages should reflect those differences in risk.

“I think from a finance standpoint, you would say absolutely,” he says. “But I think there’s a couple of other dimensions related to politics and related to equity that make that more complicated.”

“The downside to that is access and affordability for lower-income families, many of whom have lived in these potentially exposed communities for a very long time,” Keys explains. “You need a broader approach to deal with this set of challenges. I think this is really where the market can start to unravel.”

Learning lessons from flood insurance experiences

If all this sounds familiar, it should. We’ve seen these concerns play out with flood insurance, with an array of less-than-satisfying results. Efforts to increase flood insurance to reflect genuine risk have been fought by the real estate industry and coastal public officials from both sides of the aisle. The trend has been towards shoreline properties being scooped up by uber-wealthy owners who don’t need flood insurance and are willing and able to pay to rebuild after flooding.

But there’s an added wrinkle with the mortgage market’s trying to align prices with risk: A property could become a total loss, with no resale value for the owner, whether that’s the person living in it or the bank that foreclosed on it.

“If you foreclose on a house where the person just couldn’t pay, the house is still just fine. If you foreclose on a house where the people stopped paying because the house was flooded, then the value of the house has fallen as well,” Keys says.

All of this becomes more urgent given an already highly active hurricane season. The annual High Tide Flooding report by NOAA, for instance, shows the problem getting worse with sea-level rise, and a new tool by First Street Foundation shows far more properties at risk for flooding than previously thought.

Solving the problem – or at least trying to

Rhode Island is one place attempting to take on the issue – and then only obliquely. It has the advantages of being a small – make that tiny – state. It has a ton of coastline, much of which comes under state jurisdiction through the Rhode Island Coastal Resources Management Council.

CRMC is not telling banks they can’t give mortgages to at-risk properties. But it has figured out a way to warn people about coastal risk potential without flat-out prohibiting them from buying, financing, or altering those properties.

The state has a couple of tools for communities and individuals to use: STORMTOOLS, which can be used to see storm and sea-level rise risks into the future; and a new Coastal Hazard Application (CHA) guidance form that will assess risk for a minimum of 30 years – deliberately chosen because it’s the length of a typical mortgage.

The owner of any property under CRMC jurisdiction for purchase or renovation fills out the application, which then goes on file in the land evidence records as permanent future reference. That approach won’t force applicants to stop, but it’s designed to educate them, says Laura Dwyer, public educator and information coordinator for CRMC.

“They can visualize what happens if they have to leave home behind because they can’t live in it anymore,” she says. “Anecdotally, staff are using it with potential applicants, and some people have decided to go back to the drawing board once they see the results.”

In a June 1 report, “Addressing Climate as a Systemic Risk: A call to action for U.S. financial regulators,” Ceres, a nonprofit that tackles sustainability through economic and financial solutions, called on the Federal Housing Finance Authority to consider climate change as part of its regulatory oversight of Fannie and Freddie.

That report’s key recommendations were:

  • Recognize the impacts of climate risk on the housing market.
  • Engage with Fannie and Freddie to analyze mortgages they hold with respect to their exposure to climate change.
  • Develop strategies to address that climate risk, with a particular focus on the vulnerable communities disproportionately threatened by climate change.

Veena Ramani, senior program director for capital market systems at Ceres, says the impact will extend to commercial and residential markets. And she notes that the chief economist of Freddie Mac had referenced the potential risk as far back as 2001.

But what to do about it? “I don’t have a solution to that, and I think it is an incredibly complex problem,” Ramani says. “Any sort of solution that goes beyond what’s going in this report requires a much broader multi-stakeholder perspective.”

Kousky and Keys at the Wharton Risk Center have some thoughts on solutions. Both advocate targeting resources at the lower-income people facing the most shoreline risk. And they both point out that those individuals are at risk of losing both their homes and their jobs if they are employed within a shoreline community and economy.

Kousky’s suggestions include a halt to insuring of repetitive loss properties; rethinking local property tax and land use regulations; reinstating the Obama administration policy that mandated federal dollars used for disaster recovery had to include more resilient construction; expanding the Coastal Barrier Resource system, which prohibits use of federal dollars in certain high-risk areas; and changing mortgage terms in the highest risk areas, not just those on the coast.

But given strict discrimination prohibitions in lending laws, she says lenders on their own are unlikely to act in ways that could have an outsized impact on those with lower incomes. “I think there needs to be a little bit of a forcing function there,” she says.

The challenge, she adds, is that sea-level rise plus more and bigger storms means there’s a growing coastal risk. “The question in my mind is, Can we address that in a preemptive and more orderly fashion in order to prevent the post-disaster suffering that happens when we fail to do that?” she asks. “It’s really hard to motivate any sort of change until the crisis finally hits.”

For Keys, things come down to designing a system that can steer people away from risky coastal areas, discourage new development, and encourage mitigation efforts to promote aggressive adaptation.

The big question then, he says, involves how to subsidize mortgages and insurance on the low end so more can stay on the coast. “If the FHFA tomorrow said properties within a half-mile of the coast have to pay 1% higher interest rates, they could do that,” Keys says. Those are the much harder equity questions.

“Who ends up bearing the risk and who ends up paying for the adjustments that need to be made?” he asks. “That’s where things get really challenging and that’s where we have to think really carefully about the folks who can easily adjust and the people who can’t.”

This story first appeared Sept. 2, 2020, in Yale Climate Connections.