The S-Curve

Overview of Going to Extremes: Climate, Housing and Finance

Eknath Belbase

Andy and I recently attended AmeriCatalyst ‘Going to Extremes’ Climate, Housing and Finance Leadership Summit in Washington, D.C., a fantastic conference on all things related to climate risk and the housing ecosystem. While going over all the great speakers and broad expertise represented there would take a novella, I want to connect a few key ideas discussed there to our ongoing efforts in this area.

Panels on climate and property level data and on the modeling that can be done with this data generally came to an agreement that we are getting to a point where property level impacts of increasing climate risk can begin to be measured using traditional mortgage risk metrics that practitioners are familiar with once climate-conditioning of behavioral and house price models is complete. Prior to this conference, we noticed a focus primarily on event-driven analysis, and I detected a general consensus emerging that the rapid rises in insurance cost (and drop of availability in cases where states interfere with rational price setting) ought to become our primary analytical input.

A related emerging idea is that the duration mismatch between the 1-year repricing of insurance and the 30-year fixed rate mortgage creates substantial risk (this was one of the key points of Andy’s presentation).

One speaker noted that this phenomenon is very similar to the financial crisis, where the industry created 2/28 adjustable-rate mortgages (ARMs) where the teaser was affordable, only to have them blow up 2-3 years later; now the teasers are insurance policies that go from being 20% of total principal, interest, taxes and insurance (PITI) to 60% of a much higher PITI within 3 years.

We are fortunate that, at this time, most borrowers have substantial amounts of equity. While the evolution of 3- or 5-year forward insurance pricing, combined with longer-term forecasts based on the best available climate risk models that would allow borrowers to avoid the riskiest areas could go a long way towards preventing a repeat of what happened with 2/28 ARMs , such developments are not underway. In fact, the risk from higher insurance premiums is potentially higher than the 2/28 ARMs risk (since everyone with a mortgage is subject to insurance repricing risk), and at least a fifth of core-based statistical areas (CBSAs) seem to have at least 10% of their properties in risky enough areas that insurance affordability will become a concern).

Discussions on mitigation and hardening highlighted some solutions: apart from getting to net zero and using carbon capture to reduce existing CO2 (global solutions), we can broadly do two sets of things: avoid the riskiest areas and make somewhat risky areas less risky by hardening our housing and infrastructure. More modern building code standards (which have been updated to account for changing climate conditions) and property level mitigation on existing housing stock, together with local infrastructure resiliency, can reduce the severity of events enough to mitigate future required insurance premium increases.

Another idea that came up in an interview that the journalist Diana Olick conducted on stage at the conference – that in searching for solutions and contributions to solutions, we “should not let the perfect be the enemy of the good,” which connects with our efforts in at least two ways. First, it is a good modeling philosophy to have: if we wait for the perfect model before releasing it to the market, we can end up waiting needlessly. By releasing something that is “good enough” to get started, we engage with the user community and begin the process of improving our models much earlier. Our clients begin to think about use cases and ways to improve their business practices much sooner.

Second, all of our efforts broadly help our clients avoid, manage and appropriately price the risk. A vision of perfection might entail coming up with solutions that not only shift the risk among market participants but solve systemic issues that impact the entire mortgage ecosystem. The problem with this vision of perfection is that systemic solutions require the participation of many different players: companies, regulators and multiple layers of government. We can seek to both help our clients begin to manage this risk in the near term and begin to work with the larger community on system-wide solutions in the intermediate and long term. The conference did not achieve a clear consensus on system-wide solutions but clarified the extent of the problems and laid out a menu of incremental steps, each of which could contribute to solutions.