Climate change could end mortgages as we know them

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.

• U.S. taxpayers are at risk for homes threatened by climate change
• Climate change could deliver a $4 trillion hit to the financial system
• California fire insurance premiums pricing out homeowners
  

No more mortgages?

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.

"The market is short-sighted"

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."

Lower home values, lower tax collections

A UCS report Cleetus co-authored last year found that many more homes are at risk of chronic flooding than is reflected in property values. If home prices were to change to reflect this threat, many homeowners would see the value of their home plummet.

"This can be disastrous for a homeowner whose house is their largest asset and a substantial portion of their net worth," wrote Berman. "Obviously, this can result in a downward spiral of property values for such communities."

Lower real estate prices also drag down counties and cities. Because local budgets are reliant on property taxes, even a small drop in home prices can make it harder for a locality to provide basic services, like fixing roads and paying for public education.

"There is a real possibility that real estate values will be decreasing… just as the real estate tax base is being relied on for funding of new flood mitigation infrastructure," Berman wrote.

That's why many who study this issue are calling for governments to plan for what they call the inevitable retreat.

Said Cleetus: "My biggest fear, honestly, is that the markets will get out ahead of our policies, and we see a situation where property values do start to decline, and small communities that rely on a lot of property tax revenue won't be able to deal with it."