Hurricanes could trigger housing crash with risky coastal mortgages

As hurricanes and floods become more frequent and intense, the threat to coastal real estate continues to rise.

By the end of the century, around 2.4 million US homes could experience chronic flooding — the equivalent of all the homes in Los Angeles and Houston combined. That’s $912 billion worth of residential property, or around 3% of the US housing market. But only 15% of Americans have a flood insurance policy.

Mortgage lenders seem to be taking note of these risks.

A new paper from economics professors at HEC Montreal and Johns Hopkins University identified a pattern among US banks: They’ve been selling mortgages in coastal areas to Fannie Mae and Freddie Mac.

The two government-sponsored companies are supposed to make the housing market more stable and affordable, but they’re perhaps best known for their role in buying risky mortgages ahead of the 2007 financial crash. When the federal government bailed them out, it cost taxpayers $187 billion.

By purchasing a mortgage from lenders, Fannie and Freddie incur the financial risk if a homeowner defaults on a loan. And the chance of default becomes more likely following a hurricane, the new paper found.

Taxpayers, then, would be responsible for footing the bill.

Coastal mortgages are becoming riskier

The paper looked at 15 natural disasters that took place between 2004 and 2012 and caused at least $1 billion in economic losses. The list includes disasters like Hurricane Sandy, which caused an estimated $60 billion worth of economic damage, and Hurricane Katrina, which caused an estimated $82 billion.

In the first year after one of these hurricanes, the authors found, the odds of home foreclosure rose by 3.6 percentage points. Within three years, the odds rose by up to 4.9 percentage points. The authors also discovered that the share of mortgages sold to Fannie and Freddie increased by 10% after a billion-dollar hurricane, a pattern led by large national banks.

Read more: 36 photos show how extreme weather and natural disasters have gotten more intense over the years

“We didn’t slice or dice the data,” one of the authors, Amine Ouazad, told Business Insider. “I spent the last year really making sure that these results were robust, that they were representative of the entire mortgage market and the lending practices of typical lenders.”

Transferring risk to the federal government could lead to another housing crash

The study suggests bad news for everyday citizens, Ouazad said — if a disaster leads homeowners to default on their mortgages and many of those loans were offloaded to Fannie and Freddie, US taxpayers could wind up on the hook again.

What’s more, Fannie and Freddie’s involvement could make homeowners think it’s safe to buy risky coastal property, since those loans are guaranteed by the government.

“We may face another kind of subprime crisis” if things don’t change, Ouazad said, referring to the financial crisis that hit American homeowners from 2007 to 2010. That crisis originated with lenders creating a strong demand for mortgages among people who might struggle to repay them.

Climate change might prove to be the next reason homeowners can’t afford their payments.

“Are we playing the same game as in 2007?” Ouazad asked. “If flood risk becomes very large because we’ve incentivized households to live in those coastal areas, there might not be even an ability to diversify its risk.”