Double, Double, Toil and Trouble, a Climate Change Bubble

The climate change bubble is the next potential bubble in a fine tradition of bubbles (some are strange – I am looking at you Tulip Bubble).

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Echoes of 2008 Subprime Bubble

Recently, Christopher Favelle discussed a paper about mortgages and rising climate risk. The paper explains that US private banks have an incentive to offload risky mortgages onto US government institutions backed by taxpayers, effectively leaving taxpayers on the hook for the risk.

Here is a summary of their findings:

• people are buying less flood insurance policies and face an increased risk of flooding in coastal areas
• banks screen for flooding risks but still give mortgages despite the flood risks
• banks can sell these risky mortgages to the US government agencies Fannie Mae and Freddie Mac which do not screen for flooding risks
• as flooding increases, these riskier mortgages will increasingly default and the cost will ultimately be picked up by the US taxpayers (who are responsible for Fannie Mae and Freddie Mac)
• the banks avoid liability and walk away with the profits

It reminded me of The Big Short… Man, I used to watch that movie a lot. (I also listened to the same song compulsively. I think I must have traumatized a couple of my e-roommates – sorry Steve and Kris!)

Anyways, The Big Short follows traders during the 2008 Subprime bubble and housing collapse. Basically, American Financial firms started selling very risky mortgages and even hid the risk and even misled clients. When the mortgages collapsed, they offloaded their losses onto taxpayers who ate the losses by paying bank bailouts.

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Climate Change Bubble and urBetterFuture

Financial firms could again try to offload losses as the damage from climate change piles up. So, how does this impact urBetterFuture?

You might end up paying for others’ underwater houses

Lenders won’t necessarily lose their money when an owner defaults on their mortgage.

You, the taxpayer, may end up bailing out the lender. And how do you pay for the bailout?

With taxes and austerity measures.

Large businesses sometimes try to privatize profits and socialize losses. They try to have it both ways. They argue they are private entities and entitled to as much of the profit as possible. At the same time, they argue that they are vital public pillars of the economy that need public support. This means that businesses may try to get government bailouts and shift their losses to the taxpayer.

The Climate Change Bubble will be more damaging than the Subprime Bubble

A person failing to make mortgage payments won’t physically damage a house. On the other hand, flooding will. This is a key difference as the quote below shows.

...rising sea levels and spreading flood plains… appear likely to destroy billions of dollars in property and to displace millions of people. The economic losses and social disruption may happen gradually, but they are likely to be greater in total than those experienced in the housing crisis and Great Recession.

Freddie Mac research paper

It’s a lot harder for an asset to recover value when it’s actually underwater compared to the owner being merely financially underwater.

Use Investors and Markets to gauge the Climate Change Bubble

It is useful to look at investors’ actions and market trends to judge the financial risk of climate change. Markets tend to be agnostic about politics, they don’t care what the political stances – they are just looking for the best return of their money.

This doesn’t mean that the majority of investors or investing trends are always correct in predicting the future. In fact, some experts argue that investors are too slow to recognize the risks of climate change. Also, most investors also didn’t anticipate the 2008 Subprime bubble.

However, market trends are a useful source to evaluate the risk and compare against other sources of information. For instance, President Trump claimed he would reverse the US coal industry’s decline by removing and loosening regulations. According to Trump, coal has a bright future. Markets tell a different story.

It can also lead to useful observations. One expert noted that much of Coastal Florida may become uninsurable because the probability of extreme weather exceeds 5%.

How to Prepare for Climate Change Bubble

A lot of factors will be out of your control when the climate bubble hits. However, here are some steps to make your financial future more resilient.

Be Aware of the Climate-Change Risks when Buying Property

Questions include:

• How is the drainage of the property? Does it have the necessary sump pumps, weeping tile, waterproofing, etc?
• Are extreme weather events increasing in the area?
• What is the risk of flooding in the area? Is it increasing?
• How easy is it to insure your home? How many are offering policies?

Don’t Overextend Yourself Financially

Being overburdened with debt can make a bad situation worse. Have an emergency fund. Make sure you live below your means. Don’t get a large mortgage that eats up all your take-home pay.

Vote and Encourage Climate Change Action

Even though you are just one vote, it’s still a vote. Be politically active encouraging your governments to prepare for climate change and to pass laws that put the honus on businesses to handle their own climate liabilities.

Build Financial Resilliency by Practicing Sustainable Finance (it isn’t just about being a nice person)

A friend who worked in the restaurant industry advised me never to eat in a restaurant with a dirty bathroom. He said that if they are willing to show an unhygienic bathroom, just imagine what they are hiding.

The same goes for sustainable finance. If a business is willing to engage in unethical practices like child labour or clear-cutting forests, there is a good chance they will be unethical with you. Just look at Enron.

In the same vein, banks that disregard climate risks probably won’t care that a loan destroys your finance if they can profit off it. Your pain doesn’t matter to them.

As Kevin McCarthy an insurance professional notes about Florida,

banks aren’t likely to stop lending in Florida anytime soon unless something happens dramatically to shift the burden to [them] to actually have to pay.

Again, they don’t care about your pain.

I hope that you run your financial life in a way that preserves our ecological capital and makes the world a better place. I really hope that you do.

But it’s also a matter of self-preservation. If you don’t practice sustainable financing and disregard the risks of the climate bubble, you are opening yourself up to large painful risks.