Financial Times on Coming Climate-Change-Driven Meltdown in Real Estate: Gradually, Then Suddenly?

The Financial Times has an extremely informative new article, Meltdown: How the Next Financial Crisis Starts, on the certainty of the loss of considerable financial wealth due to insurers becoming unable to provide coverage for heretofore routine property risks as a result of climate change. I urge you to read it in full. It confirms our earlier coverage on this subject.

However, the title misrepresents the piece. Experts aren’t close to the “I begin to discern the profile of my death” phase.¹ The story features experts who are highly confident that huge swathes of the US real estate market are certain to suffer a major price plunge as mortgages become unattainable due to the inability to get insurance. They further posit that this will lead to a collapse of other services, particularly banking, since with mortgages a major source of branch profits, banking services are no longer profitable and many locations will be shuttered. The article does not discuss commercial property, but there are similar obvious concerns about what happens to retail and office space in a world where their value is also drastically lower due to the inability to sell them to anyone other than a cash buyer….who also is exposed to the risk of climate change incidents and routine “shit happens” fires.

One of the big questions is how fast the implosion happens. While the article starts by envisioning the possibility of a 2008-level implosion, they don’t deliver much of a case as to why. Recall that Japan had far bigger (relative to GDP) real estate and stock market bubbles in the late 1980s, yet did not have a market seizure. It instead had zombification. Then many years into the crisis (1997), it tried going into “Mission Accomplished” mode, relaxing some constraints, and then some financial institutions did fall over.

As we explained long form in ECONNED, the sudden shock of the Lehman crash was not the result of a real estate bubble deflating (which if that were the driver, would have created a savings & loan and half level seize-up) but a derivatives crisis. Derivatives written on the riskiest tranches of subprime securitizations were 4-6x the value of those instruments. And unlike losses on mortgages, where recoveries historically were about 70%, most of these tranches went to zero, and so to did the derivatives. Oh, and those exposures were significantly on the balance sheets of systemically important, overleveraged finance giants.

However, a variant of Japan in the 1990s is plausible: a slowly accelerating decline, and then a plunge from there, in classic Hemingway bankruptcy form.

We’ll turn after looking at the “profile of the death” issue to a discussion of whether interventions to try to make things less bad will make them worse. The default answer on topics like this is “yes”. We’ve regularly discussed the concept of obliquity, which in simple terms is the finding that when dealing with highly complex, adaptive systems, trying to cut simple paths through them generally takes you in the wrong direction.

Keep in mind also that the authors presume that this “meteor hitting Planet Earth and killing all the dinosaurs” level event is the driver of a coming crash, whether slow motion or not. There is so much overvaluation and excess leverage, with financial asset prices in the main not adequately pricing that in, that there are many other proximate causes for a financial crash: an emerging markets crisis rolling through exposed economies and having a measure of contagion to the advanced world; resumption of Israel/US aggression against Iran leading to an oil price spike (or perhaps even an embargo), Trump escalating his tariff war one times too many (and/or even the impact of his supposedly interim tariffs leading to contractions and failure that start to lead to defaults, for instance among highly leveraged private equity/private debt plays).

So while the coming real estate crisis is poised to eventually become The Mother of All Financial Crises, it may not be the first to get going in a big way.

First to the pink paper’s experts forecasting how this decline will unfold:

In January, the Financial Stability Board, which was set up to keep an eye on the global financial system after the 2008 crisis, said insurance was becoming more costly and scarce in disaster-prone areas and “climate shocks” could set off wider market turmoil. In early February, US Federal Reserve chair Jay Powell warned that the Fed was also seeing banks and insurers pull out of risky areas. “If you fast forward 10 or 15 years, there are going to be regions of the country where you can’t get a mortgage. There won’t be ATMs [and] banks won’t have branches,” he told Congress. “….

Then, as Europe experienced its hottest March on record, Günther Thallinger, a management board member at Germany’s insurance giant Allianz, warned global temperatures were fast approaching levels where insurers would no longer be able to operate, creating “a systemic risk that threatens the very foundation of the financial sector”.

“If insurance is no longer available, other financial services become unavailable too,” he wrote in a LinkedIn post that made headlines. “The economic value of entire regions — coastal, arid, wildfire-prone — will begin to vanish from financial ledgers,” he added. “Markets will reprice, rapidly and brutally.”..

There is no single scenario…But here is one that has emerged…

It begins with the number of insurers pulling back from US states swelling from a stream to a flood…homeowners face soaring premiums or an inability to renew their cover…

Cash-strapped governments try to plug the gaps with more last-resort insurance schemes. But these plans typically cost more and cover less, raising a chilling new reality for thousands of homeowners. The value of their family home, which had risen year after comforting year, instead begins to sink.

We wrote in January how this pattern has started in Florida and California. Notice that part of the pattern is to try to socialize risks of badly-exposed areas (which by a cold calculus should either be insurable only at nosebleed prices or not at all) to ones that at least as of now don’t seem much to be in harm’s way. So there is also a simmering political question of why exactly should those live inland, for instance, subsidize properties near the coast?

And these patchwork schemes are already starting to come unglued. As we wrote:

As with the odds of success of the West against Russia in Ukraine or America in a military contest with China, there’s rampant denial of the impact of climate change on property values (commercial as well as residential) in at-risk areas. Along with that is undue fixation of trying to tinker with property insurance as if that could somehow combat the fact that losses are sure to swamp the ability of anyone but perhaps governments to pick up the tab. And that’s not a viable solution.

Socialization of risk on this level, particularly given the lack of precedents, is already intensely political and will become only more so. And there’s no consensus on what to do. There are still quite a few who regard talk of global warming as a World Economic Forum “eat your bugs” plot. Climate cognoscenti argue for relocating people and communities to more “sustainable” places. But many are unwilling to move. So as things get more dire, what draconian measure will be imposed to dislodge them? Condemning entire communities with the required eminent domain payoffs? Or resorting to cheaper forms of coercion, like cutting off power or water or garbage services?

Or consider what is happening in Los Angeles. We’ve pointed out that allowing rebuilding with wooden homes is asking for more of the same. But wood-framed houses are likely the cheapest option. But new construction is going to be beyond the means of most, even in the wealthiest neighborhoods…

And there’s been resistance by burnt-out residents to the idea of rebuilding the less affluent Altadena area as apartments. But there’s no other realistic option given the typical financial situation.

And this points to a second general problem as to what to do next. No one seems willing to lower the hammer and change zoning requirements in climate-whacked neighborhoods so as to greatly reduce their vulnerability….

In other words, there’s widespread rejection of a new normal: that a downward reset in living standards and/or wealth that many (most?) Katrina victims suffered is in store for all but the wealthiest climate change housing casualties. And as climate damage to real property accumulates, those values will similarly reset in a big way. But due to the way the US property and casualty insurance industry operates, and the problem we flagged above, that the kick-the-can approach is to try to forestall the inevitable with insurance, it will happen on a state-by-state level as opposed to community level.

In other words, as we’ll describe, the inertial path is that in states with large climate change exposed regions, the entire states will have unaffordable or barely affordable home insurance. That means property values will fall. Even cash only buyers face high insurance costs or bearing the risks themselves. For buyers that can’t stump up a purchase price, their ability to borrow will be greatly constrained because they have to be able to afford the insurance premiums, and that will eat up so much from a monthly housing budget that very little would be left for mortgage payments. Much lower mortgage borrowings means much lower housing prices…..

We recently cited an article from Dissent which focused on what has become the three card Monte of Florida’s insurance market to argue for a public model. But as much as that scheme is internally coherent, it foresees a level of government intervention in housing that’s not workable in America, even before getting to the Trump libertarian takeover effort underway. But what is happening in Florida looks all too likely to happen in some form in other afflicted states, particularly California. Remember the key fact that insurance is state regulated and each insurer writes policies via an entity in that state. So insurers fail on a state-by-state basis. They can also stop operating in that state. Home insurance policies are typically renewed annually, which is when price increases occur.

It’s not hard to see that a death spiral has begun. From Dissent:

More than a dozen insurance companies have exited the Florida market in recent years, and just since 2022 at least six insurers in the state have become insolvent—leaving homeowners scrambling to find new providers, typically at drastically increased prices.

Florida’s political leadership has attempted to address these problems with market deregulation and financial incentives. Several public institutions also help to prop up the private insurance market, including Citizens Property Insurance Corporation, a nonprofit public company created as an insurer of last resort in 2002, and the Florida Insurance Guaranty Association, a state-run fund that pays policyholder claims in the event that an insurer goes bankrupt.

Despite these efforts, Florida is having trouble retaining large, national, diversified insurance companies, which are more financially stable and often more affordable. The private insurance companies still operating in Florida are primarily newer, smaller companies that conduct almost all of their business in Florida; some have an even narrower focus, such as one company that primarily sells wind-only policies in South Florida….

Policymakers in the state have responded with measures to raise Citizens’ premium rates and further encourage depopulation. These measures mean not only that Citizens rates are going up in several parts of the state—one analysis found that Citizens will have to raise rates in Miami-Dade County by 80 percent in order to comply with a state law that forbids it from competing with private insurers—but also that private insurers can easily obtain a swath of new customers who will have to pay higher rates. Meanwhile, with Citizens now responsible for a tenth of the states’ policies, it may not have enough capital to fully pay out claims after major disasters.

To address this issue, state leaders have permitted Citizens to levy emergency fees on nearly all statewide property insurance policies for as long as is required to repay debt. This means that a serious financial loss for Citizens and other Florida insurers could result in additional fees for residents already dealing with a catastrophe. The Florida Hurricane Catastrophe Fund (a state-run provider of insurance for insurers) and the Florida Insurance Guaranty Association are backed up by yet more emergency fees on policyholders, meaning they could face multiple stacking fees during a devastating hurricane season.

Forgive the detail, but you can see the drift of the gist. More insurers are leaving Florida. Some have gone bankrupt, with the costs imposed on the surviving insurers, meaning in the end their policy holders. The new entrants aren’t all that strong, financially. Citizens is already imposing what amounts to an emergency levy on all policy-holders (not clear if the surcharges are higher in higher climate exposure areas or not).

Back to the current post. With the cracks in the current system becoming fissures in at-risk jurisdictions, it’s not hard to see why expert freakout is starting to go mainstream.

The Financial Times curiously skips over the problem we just recapped, of how trying to shore up property insurance market is destined to fail because these risks are becoming too large and frequent to be insurable. It turns to a different matter, that the fight over climate remediation (the Green New Deal and all that) can also become destabilizing. Erm, to me this is arguing about whether rearranging the deck chairs on the Titanic impeded getting passengers into lifeboats. Yes, at the margin, some moves are better than others, but the policy/governing “we” can do perilously little to change the direction of travel. We are way past the point where Band-Aid level interventions based on the fantasy that over the next 40 years, it will be possible to preserve modern living standards on their current scale.

The article contends that the size of climate events themselves could induce a crisis and are abandoning old-think that “transition risk”, from creating fossil fuel stranded assets (which is coming to include internal-combustion-engine auto operations), was a more serious hazard than climate-created damage:²

Meanwhile, signs of the physical climate risks that initially seemed more remote than transition threats have grown ever more apparent. Monster rains brought Dubai to a standstill in April last year and forced thousands to evacuate in China. Hundreds died a few months later when Typhoon Yagi roared into south-east Asia. In October, authorities in Florida were still dealing with the wreckage left by two enormous hurricanes that slammed into the state within an unusually short 13 days of each other when disaster hit the Spanish province of Valencia. More than 200 people died after a deluge dumped a year’s worth of rain in hours.

Less than three months later, the world watched as enormous wildfires brought chaos to the Los Angeles area, killing dozens and razing thousands of homes including the mansions of Hollywood celebrities.

The pace of destruction has continued this year. In March, South Korean leaders said deadly wildfires sweeping the country were the worst in the nation’s history, while Japan ordered thousands to evacuate from its worst wildfires in decades. Massive wildfires have forced thousands of Canadians to evacuate, and Australia has faced a disastrous set of floods that officials say hit economic growth. This month, authorities issued extreme heat warnings across North America, Europe and Asia….

“My thinking has always been that transition risk is a bigger risk for the financial system because it can take the form of very sudden shifts that lead to huge financial losses,” says finance professor Patrick Bolton…“But I think what we’ve seen with the LA fires and other unexpectedly destructive disasters is that we’re already now in the territory where physical risks could be a threat to the financial system.”

Banks have had a similar rethink, says a financial services strategist who has worked on climate stress testing for nearly a decade.

Again, this “too little, too late” recognition of rapidly advancing ugly realities is painful to watch and difficult to explain, save via the Upton Sinclair saying, “It is difficult to get a man to understand something when his salary depends him on not understanding it.” But the reason soi disant leaders get the big bucks and special privileges is that they are supposed to be somewhat resistant to those incentives and more oriented to preserve the systems which allow them to wield power. But forty plus years of neoliberalism and libertarianism have crushed whatever was left of those impulses.

I am reminded of a scene in the great movie, The Lives of Others, which focuses on the police state in East Germany right before the fall of the USSR. After the end of East Germany, playwright Georg Dreyman encounters former East German Minister of Culture Bruno Hempf. Hempf’s abuse of his surveillance and coercive powers in his unsuccessful pursuit of Dreyman’s muse and lover, actress Christa-Maria Sieland, led to her death.

In this conversation, Hempf reveals his thuggishness, depicting Dreyman as unable to satisfy Sieland based on intense monitoring of the couple, which was news to Dreyman.

Dreyman keeps his composure and says, “To think that men like you once ran a country.”

This is the fix we are in collectively, except the corruption and incompetence are very much in progress.

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¹ From Marguerite Yourcenar’s Memoirs of Hadrian.

² Lordie, it must have taken a lot of indoctrination to believe that (destined to be not effective enough) “transition” policies were a bigger hazard than the baked-in climate crisis.