8

CLIMATE CHANGE IS GOING TO TRANSFORM WHERE AND HOW WE BUILD

by John D. Macomber

As fires, floods, and droughts increasingly threaten homes, businesses, and other institutions, climate risk has become a financial risk. A National Bureau of Economic Research paper recently concluded that mortgages written on homes in exposed locations are being shed by banks and absorbed by Fannie Mae and Freddie Mac, government-backed mortgage guarantors.1 This implies that homeowners and investors have been making location decisions without properly pricing the cost of potential peril, and that the government has been enabling the oversight. Some are even warning that this market failure could lead to a repeat of the 2008 financial crisis, which was also triggered by bad mortgages.

It’s not just homeowners investing recklessly—many businesses have been equally shortsighted in where they place new assets, such as factories, and what to do with existing assets in once-safe areas now threatened by these perils. While laudatory efforts continue to mitigate climate change at the international level, it’s long past time to accept that the climate is already irreversibly changing, and we must adjust our mindset accordingly. We can’t just keep piling sandbags, pumping basements, dousing flames, and expecting government bailouts forever; a methodology is needed for homeowners, businesses, mortgage holders, governments—all of society—to figure out which assets to reinforce and what other courses of action are available.

Alas, we seem to be headed in the wrong direction. While virtually no private insurance companies retain residential flood risk in Florida, Virginia, and other coastal states due to sea rise, government-subsidized programs such as the National Flood Insurance Program (NFIP) continue to keep residences insured. Making things even worse is a general lack of restrictions on where one can build and what can be built. A society that prides itself on free will and self-determination is loath to say what a property owner can and cannot build on their own land as long as it meets rudimentary building and zoning codes, so more and more people move into harm’s way in flood plains, low-lying coastal areas, and tinder-dry Western landscapes.

Why this dysfunction? To begin with, all three of these factors—mortgages, insurance, and land development policies—are by design backward looking. They rely on histories of lending defaults, insurance claims, and floods and fires to make determinations. This is logical; there is plenty of hard empirical data to draw from, and a switch to looking forward would risk becoming a matter of speculation over the merits of one modeling method or another. There are also plenty of market incentives to keep housing prices high. But the backward-looking approach seems overwhelmed today as climate events—and follow-on effects on the ground—are moving so fast.

There is a better way. My research and that of others indicates that there are five basic choices in investing in resilience: reinforce, retreat, rebound, rebuild, and restrict.2 Together, they can be used as a decision-support tool for what to do with assets exposed to climate risk.

Reinforce

This is often the default recommendation in the face of climate-related perils. But only in some circumstances is it is the right reaction. A good example is Texas Medical Center (TMC) in Houston. Following severe damage from Hurricane Allison in 2001, TMC invested hundreds of millions of dollars in resilience improvements, including flood bulkheads, sky bridges, elevation of electrical equipment, and more. When Hurricane Harvey hit in 2017, Houston was soaked by unthinkable amounts of rain and the regional flooding persisted for weeks—but with its resilience interventions in place, Texas Medical Center hardly missed a beat. Investing in reinforcement made sense in this instance because, first, the direct and indirect costs of being hit were huge; the hospital had the ability to raise the capital even though the investment in resilience was not sure to pay off (since there might have never been another big storm); and, second, because the incremental capital spending relative to the entire balance sheet was manageable. But not every potential investment in resilience makes economic sense. We can’t pay for a blanket policy to resist sea rise and rainfall and fire in every situation forever, regardless of cost/benefit. When should a different route be taken?

Retreat

Consider the opposite scenario. After several consecutive years of being overwhelmed by riverine flooding, multiple small shopkeepers and restaurants in Ellicott City, Maryland, collectively abandoned the historic downtown for higher, dryer land. This was the right course of action for them: The cumulative flooding had a substantial cost relative to their balance sheets; the price to reinforce (by raising floors or building sea walls) was too high, and resources were thin.

Rebound

In Miami and Miami Beach, most new commercial or condo buildings on the water are built with extra-high first floor elevations (“freeboard”), with expensive equipment located out of harm’s way on the second floor or higher, and with furnishings and materials at ground level and in the basement that can survive temporary seawater inundation, be pumped out, be cleaned quickly, and then put back in service. The famous wooden plank walkways on St. Mark’s Square in Venice are similar: They embrace neither reinforcement or retreat, but rather are focused on “living with water”—how to rebound in a cost-effective way.3

Rebuild

This is essentially the path chosen by the homeowners in Houston, Texas, or the Hampton Roads area in Virginia, where FEMA has paid to rebuild thousands of homes multiple times each. Rebuilding is a great choice—particularly if you are rich or if you can use someone else’s money. The long-term questions, though, are: Will there always be that money available? Will it go to those who are most in need or to help higher-income individuals, as reported by U.S. News and World Report?4 And, of course, how long will the other taxpayers support aiding those in danger zones? In recent years, Congress has authorized about $200 billion per year for disaster relief in California, Iowa, Texas, Florida, New York, Puerto Rico, and elsewhere (on top of subsidizing the NFIP). It’s not clear that, in a time of deficits, this largesse will be perpetual.

Restrict

This is a strategy that the private sector mortgage and insurance companies appear to already be following—they are not investing in harm’s way and, based on press reports, they are drawing back. Some other large asset owners such as real estate investment trusts or retailers thinking about store locations are avoiding purchasing or building properties in high-risk areas. But there is a public policy angle, as well: Recently the utility PG&E was forced to pick up the cost of property damage from California wildfires. A strong argument could be made that the local government should have restricted these structures from being built in the first place.

In the coming years, growth pressures will increase in many attractive locations (such as coastal cities and Western states). Americans will be forced to make some tough decisions. Subsidized mortgages and artificially cheap insurance have let us put off the hard reckonings a little longer, but if a severe price correction (and subsequent economic shock) is to be avoided, all asset owners in potentially exposed locations will need to pick one of these five paths for investing in resilience. The right choice in each situation depends on circumstances, the level of exposure, the cost of potential damages, the cost to reinforce, and resources available. The challenge for homeowners, investors, mayors, and all of us is to look ahead, not behind, and to make these choices with intent—before circumstances take the choices out of our hands.

TAKEAWAYS

Businesses need to think about where they are placing new assets and what to do with existing ones that are now threatened by extreme weather events. Five basic choices in investing in climate resilience can be used to help you decide what to do with assets exposed to climate risk:

  • Reinforce building structures through flood bulkheads, sky bridges, or high walls to protect against extreme events.
  • Retreat by moving assets and people away from climate-endangered areas.
  • Rebound by introducing building features designed to deal with damage—for instance, lower levels that can deal with flooding—without hurting the overall structure.
  • Rebuild after disaster, using government aid and other funding.

    Restrict building by avoiding purchasing or building properties in high-risk areas or through strict zoning laws.

NOTES

  1. 1. Amine Ouazad and Matthew E. Kahn, “Mortgage Finance in the Face of Rising Climate Risk,” NBER Working Paper 26322, September 2019.

  2. 2. Regional Plan Association, “Where to Reinforce, Where to Retreat?” Fourth Regional Plan Whitepaper, May 22, 2015. https://www.rpa.org/publication/fourth-regional-plan-whitepaper-where-to-reinforce-where-to-retreat.

  3. 3. Urban Land Institute, “The Urban Implications of Living with Water,” June 19, 2019, https://boston.uli.org/uli-resources/the-urban-implications-of-living-with-water/.

  4. 4. Cecelia Smith-Schoenwalder, “Study: FEMA Flood Buyouts Favor the Wealthy,” U.S. News and World Report, October 9, 2019, https://www.usnews.com/news/national-news/articles/2019-10-09/study-fema-flood-buyouts-favor-the-wealthy.

Adapted from content posted on hbr.org, October 16, 2019 (product #H0583W).

..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset
18.116.42.208