Mortgage Market Risks Amid Climate Change #

As sea levels rise and natural disasters intensify, homes in low-lying coastal and arid mountain areas begin losing value, creating financial risks for Fannie Mae and Freddie Mac. These government-sponsored enterprises back half of the nation’s outstanding mortgages, maintaining market liquidity by purchasing and securitizing loans. Recently, there is growing recognition of climate change as a potential destabilizing factor in the financial system.

Despite reports and summits, the Federal Housing Finance Agency has yet to offer substantial guidance to protect these entities and borrowers from climate-related risks. This issue also involves taxpayer risks because the federal government placed Fannie and Freddie in conservatorship in 2008. The enterprises have reserve capital buffers, but significant losses could necessitate government intervention.

Concerns about rising housing costs affect progress towards addressing these risks. Low-income households, disproportionately residing in high-risk areas, would be more impacted by increased mortgage costs. Interviews suggest that fear of increasing homeownership costs has stalled meaningful action.

Evidence of climate risk in mortgage portfolios has grown over years. Homes at flood risks are overvalued by $187 billion, and federally backed properties may incur $190 billion in flood damages over 30 years. Banks are becoming cautious about lending in flood-prone areas, but the enterprises do not formally consider such risks when underwriting loans. Instead, Fannie and Freddie have depended on insurance to manage these risks, particularly in federal flood zones.

“This is all about the safety and soundness of the enterprises.” Major flooding events could lead to economic declines as employers exit and local government borrowing capacity wanes. Continuing to subsidize mortgages in these areas could have negative consequences.

Historically, a diversified mortgage portfolio has minimized significant losses for Fannie and Freddie despite disaster-related spikes in delinquencies. However, if climate risk becomes apparent in home values, that could change. “If you’re just looking backwards, it looks like the system handled it.”

Fannie and Freddie charge fees to guarantee mortgages, avoiding geography-based pricing, deemed too risky politically. These areas are often home to lower-income, minority homeowners. Raising fees in these regions could harm property values and complicate housing access.

“We cannot change the fact that in Florida we have hurricanes, so we shouldn’t be penalized for it.” Initiatives to scale fees based on income or provide subsidies for relocation could alleviate impacts. Structures to withstand disasters could be prioritized, drawing on successful examples like Alabama’s enforced coastal roof improvements, which have helped avoid insurance crises.

As the Biden administration emphasizes housing affordability, efforts to incorporate climate risk in federal mortgage underwriting face challenges. Some advocate for calculator standards for new federally financed homes, which could curb emissions and reduce costs, preventing defaults.

“That they would sit on this is sort of like avoiding politics by being political and ignoring the science.” Policymakers have considered ending conservatorship, giving Fannie and Freddie more flexibility. In doing so, they hope to better hedge against exposure to climate risks. “The obstacle to pricing this really is fundamentally a political one.”