Climate Change – Is It Affecting The Mortgage Industry?

Climate Change – Is It Affecting The Mortgage Industry?

Host Michael Chabot talks to Sean Becketti, Principal with Elliott Bay Analytics, about a Research Institute For Housing America (RIHA) special report he authored on climate change and the mortgage industry. According to recent research, climate change triggered by global warming could have an impact on the behavior of portfolio lenders, GSEs, the federal government’s FHA / VA loan program and mortgage investors. This is due to extreme flooding, rising sea levels, and more storm surges that includes increased snow coverage and severe droughts. These extreme changes in elements creates more risk among industry stakeholders.

This is an excellent podcast that explains how the federal government, Fannie Mae, and Freddie Mac are responding to climate risks. Find out what to know about an area before you buy or help a client sell or purchase a home.

Host Michael Chabot talks to Sean Becketti, Principal with Elliott Bay Analytics, about a Research Institute For Housing America (RIHA) special report he authored on climate change and the mortgage industry. According to recent research, climate change triggered by global warming could have an impact on the behavior of portfolio lenders, GSEs, the federal government’s FHA / VA loan program and mortgage investors. This is due to extreme flooding, rising sea levels, and more storm surges that includes increased snow coverage and severe droughts. These extreme changes in elements creates more risk among industry stakeholders.

This is an excellent podcast that explains how the federal government, Fannie Mae, and Freddie Mac are responding to climate risks. Find out what to know about an area before you buy or help a client sell or purchase a home.

Michael Chabot
Hey guys, welcome back to another episode of Your Mortgage Matters brought to you by Angel Oak Home Loans. I’m your host Michael Chabot. We have an amazing episode for you today. Our guest is Dr. Sean Becketti. Dr. Becketti is a financial industry veteran with four decades of experience in academics, government and private industry. Over the last two decades, he has led proprietary research teams at several leading financial firms responsible for the models, underlying the valuation hedging and relative value analysis of some of the largest fixed income portfolios in the world. He served as chief economist for Freddie Mac, and written extensively on housing issues. Dr. Piketty is the author of a book on time series analysis, and is currently working on a new book on data science. He received his PhD in Economics from Stanford University, Dr. Becketti, welcome to the show.

Sean Becketti
Thank you very much.

Michael Chabot
It’s my pleasure, sir. And while PhD in Economics from Stanford, that’s quite a feat.

Sean Becketti
It felt like at the time it took a bit to do.

Michael Chabot
So I’m just really excited to have you here today. I know we were talking before we started recording. And you wrote this amazing study. The RHA Research Institute for housing America, and it’s entitled The impact of climate change on housing and housing finance, I think really the first question which I haven’t asked you is what led you to write this study?

Sean Becketti
I’m actually have known the chief economist at the Mortgage Bankers Association for a long time and rehab, Ri, AJ is their Think Tank. So they commissioned studies on different topics that they think will be important to their members, and, and the, it’s a nonprofit arm of the NBA. So the tax laws indicate that you you can’t advocate a policy within a study done under rehab. Got it, you have to be factually based, and sort of even handed, and then the Mortgage Bankers Association and say, Well, you know, here’s a statement of the facts. And now here’s how we feel about them. And here’s what we recommend as the MBA. So Mister Mr. Ratan Tony was the chief economist, gave me a call and asked me what I was thinking about this topic I’d written previously on it when I was chief economist at Freddie Mac. I actually had been thinking about it a lot. I’d been talking to other people in the industry that think about this topic, thinking about it specifically related to housing finance. And he said, Well, he was looking for someone to help lay this foundation for them. And as a result, I accepted and it turned out to be, of course, more work than I had anticipated. But it was, it was nice that it helped flesh out some of what I thought and knew about the topic.

Michael Chabot
Yeah, it’s it’s an amazing study. I’ve actually read it twice. Because I think the first time going through you miss some of the things because there’s it’s just packed with so much information. And I would say as a consumer, you know, I work in housing finance, but as a consumer, I don’t think you relate climate change and, and having an impact on buying a home financing a home, etc. Would you agree?

Sean Becketti
I’d say for most people, no, I think more and more people are starting to become aware that that’s one more factor in deciding on a home purchase. I moved to Alexandria, where I live now, back in 2016. And the first thing I did when I thought I had found a home I wanted to buy was look at the FEMA flood map to see where we were and and we’re in a actually not a not a flood zone on the map. I probably do more due diligence now, if I were doing this over again. But I would recommend at least that much for people.

Michael Chabot
And I think you and I discussed this when we had our phone call setting up this interview. So we have a division within our company that’s in Louisiana. And I never realized that New Orleans is below sea level.

Sean Becketti
It’s like that once

Michael Chabot
Wow, built, built an entire city below sea level, but

Sean Becketti
it wasn’t always it’s you know, it’s sinking. Yes. Some of it is just the nature of where it is and the way the Mississippi River works. Some of it is the result of a lot of oil drilling that take a lot of the support out from underground.

Michael Chabot
So before we get into this study, which is fascinating, I want to just kind of talk about the realities of climate change that we’re seeing throughout the world. And I know we said you know, we don’t want to really scare people. But we do want to talk about it because it’s a real thing. And I love that. One of the things in the study you talk about is the difference between climate and weather. Sure, and on that,

Sean Becketti
so Well, the catchphrase that the EPA uses is, climate is what you expect weather is what you get. And weather each day can be very different from the average, which defines your climate. So the other way to think about it is climate is weather plus time, is how things develop that how things average out, in, in the past, you know, with with climate very being very stable for hundreds and hundreds of years. You didn’t think about that very much. Now that climate is actually trending and has been for the last century and a half. That becomes more important. So just planning based on what the climate was like in your area, when you were growing up is probably not a very good way to gauge the future.

Michael Chabot
You know, I there was one thing I really found fascinating, because we’ve all heard, you know, greenhouse gases. But the reality is, in your study, you talk about greenhouse gases are a necessity otherwise, the average temperature around the world would be about zero degrees Fahrenheit, right?

Sean Becketti
Oh, yeah. No, it’s It’s striking that with what has kept the earth comfortable for us to live in for the for centuries, has been some amount of greenhouse gases in the air because it helps retain heat from the sun’s energy that if it was just the sun’s energy alone, and nothing to retain it, we, as you said, we’d be much colder it would be pretty life would be pretty much impossible. The difference now is that we have a little bit too much of a good thing. Yeah,

Michael Chabot
I found that really interesting. Because, you know, for so many years, I think just those of us that that don’t know enough that aren’t well enough educated on the topic, I think we just think that, you know, greenhouse gases are automatically bad. No, not at all. So I love this quote in the study, and I want you to expand a little bit in recent years extreme weather events have revealed the significant vulnerability of ecosystems and many human systems. I want to talk about that a little bit, because I think we only, you know, as consumers and human beings, you know, living on the earth, I think we just think about, well, maybe it’s just going to get hotter, we’re going to get more rain. But there’s a lot more to it than that.

Sean Becketti
Oh, sure. You know, the, there’s, there’s two sort of factors in this one, on average is going to be the trend in the climate. And the averages are bad enough as it is. But part of the change is that it is increased the extreme events they’ve made, the more extreme. So you will talk about, oh, the average sea level is going to rise by whatever it’s going to be in that particular area, a foot, half a foot three feet. But the storm surges increased by much more. So if you’re in a coastal area, and just knowing that, oh, well, we’ll have, you know, some intermittent flooding more frequently over the course of a year that underplays or underestimates the extreme events that you’re likely to face. Also. Extreme events have the capacity to overwhelm the systems that we have for normally dealing with rain and wind and fire. The you know, if you have extreme flooding, the infrastructure that you built to protect the community, the storm drains, the ways that protecting the buildings, you can be overwhelmed pretty easily. And so Avast become more of an issue. And one of the key focuses, when I wrote the paper was, how can we also overwhelm the financial system that we built to protect or to facilitate housing. The United States has a almost unique system of housing finance, it’s not replicated anywhere else in the world. People, you know, sort of think of the 30 year fixed rate mortgage as a birthright here, but you went to the UK, you would not find it available in the market, you’d be you’d have a floating rate very quickly. And to make all this work, and make 30 year mortgages work period, we’ve built a system of insurance system of allocating risks between lenders, homeowners, servicers, investors, that has worked really smoothly and It’s one of the it works so smoothly that people don’t notice a darn aware that it even exists until something goes wrong, say 2007 2008. All of a sudden, people discovered, oh, wait a second, there’s all these other pieces of the mortgage universe that have to work smoothly. There’s this thing called MERS, which tells you who actually owns your mortgage. And you know, who ever heard of that? Well, when extreme events happen, or disruption happens, then all of a sudden, you see which parts of the system are resilient, and which might need a little more shoring up. Yeah.

Michael Chabot
Yeah, it’s, it is very intricate. And you’re right. It’s funny when I have clients that come from the UK, and I say to them, you know, are you interested in a 30? year fixed? They’re like, No. They don’t know what it is.

Sean Becketti
Yeah, yeah. No, you’re

Michael Chabot
definitely lucky here. So, again, not to scare anybody, I just kind of want to set the table on the risks if we continue to move forward the way we have been in the past. We’re talking, I’m gonna let you expand what we’re talking issues with water resources, crop yields, increased heat waves, more heavy rain and precipitation events, correct?

Sean Becketti
Yes, definitely. So the best source for this sort of information is a group called the Intergovernmental Panel on Climate Change, which is an organization which is headed up by the United Nations, but other climate related organizations are members of this. And this group doesn’t actually conduct any research itself. What it does is it reviews the research that’s accumulated over the past few years, and presents what’s the international scientific consensus on climate change both as it is today, and what we might expect through the rest of this century. The IPCC this particular group issues reports, maybe four or five years apart. So the last one was in 2015. And it gave us a sense of where we were, which was sea levels were clearly rising. That was great. Let me step back, just one second, that, that a lot of the confusion about climate change has to do with the relation between global warming and climate change. Global warming is not a debatable issue. It’s just if if your thermometer which is working accurately says it’s 70 degrees outside, you can’t argue about whether it’s 70 degrees outside. So we have thermometers around the globe, measuring the average temperature, and how it’s increased over time, it’s increased in lockstep with the increase in the concentration of greenhouse gases in the atmosphere. So that part is not really up for debate. And that’s one of the confusions people go goes global warming, real global warming, you don’t don’t have to argue about what global warming will do and has done to the climate is a little tougher to peace out. And you can actually have debates about Well, is it how much is global warming contributing to sea level rise? Or is it contributing to sea level rise? How much is it contributing to wildfire risk? And the science of those sorts of questions, has been under rapid development over the last few decades. So the 2015 summarize, what did we know at that time? And we certainly knew sea levels rising under a lot of different scenarios. And one of the difficulties of forecasting is it’s not just the physical science, but it’s what are government’s going to do about climate change? Are they going to put in restrictions on fossil fuel burning? Are they going to develop ways of making communities and homes more resilient or not? And those as we know, right now, in Glasgow, they’re debating these issues. And it’s, it’s still up in the air about how much is going to be done. So the IPCC says, well, we don’t know exactly what the world is going to do. But there are several scenarios where we want to consider the most optimistic is one that’s similar to the Paris accord of holding global warming down to one and a half to two degrees centigrade over where it was in pre industrial times. But there are other scenarios that are more severe than that. So where did we think we were in 2015? While weaknesses sea level rising, we saw increased flooding, especially coastal flooding, but in Flooding as well. We saw increase in heat waves. That seems to be a bigger factor than it used to be. We saw an increase in wildfires. Those are all events, specific things that we think about, you know, Oh, is there a flood? How are we going to recover? How are we going to rebuild. But this also have impacts on the broader ability to sustain life. So, because we’ve changed the average temperature, or the most extreme temperature in areas, certain crops no longer do well in that area. So there’s food insecurity, as we rural the agricultural viability of rural areas, is imperiled. I know one thing that caught my eye, since I happen to be someone who enjoys a glass of wine with dinner, is that the French have finally had to loosen the rules on what grapes can be grown legally in the Bordeaux region, because the classic grapes are not doing as well in the climate. And so they’ve adopted some of the Mediterranean grapes, like all butter union, real hot from Spain, which will grow in that area.

Sean Becketti
England, which is has not traditionally been a big one Exporting Company, for the last 1015 years has started to produce really outstanding champagne. So that’s the upside of climate change. We can get some good things. But why this shouldn’t make us feel very sanguine is plants, plants can’t move very easily, you know, the vegetation can’t adapt the way that you a human who is living near the coast and the water starts to encroach in this area can move, but you can’t change the whole forest, you can’t change a whole, you know, bio structure in a region. And there’s a lot of evidence that the that plants are finding it really hard to adapt. In addition to the plants, the animals that eat those plants can’t adapt very easily, they can migrate a bit, but you know, there are limitations to what they can do. Going one more step up the food chain. Humans may be forced to migrate certain areas will have heat in the summer that will make it hard to conduct work outdoors. So that I know that one thing that I came across as I was doing this research, the Department of Defense has been doing a lot of studies, because they’re all over the globe. And they’re they see every possible version of climate change. And they’re areas where it’s very hard with their equipment to have troops in place effectively. So big changes.

Michael Chabot
Yeah, I mean, it’s, it affects so much you hit so many things there. And for example, where you have, you know, my previous place where I live with California, wildfires on the rise, heat, you know, summers hotter and hotter than they’ve ever been, you know, you talk about where you won’t be able to work outside, I know, you know, my parents were tired to the Palm Springs area, their their average temperature is now in the summer into the 120 degree range. Right. So it’s, it is a real thing. And that transitions. Now I want to get into the thank you for doing such a great job of laying it out. I want to transition to now what what the study is really about is how this all affects housing and the finance of housing. And I know a lot of people who are listening probably say, Hmm, climate change isn’t real, it doesn’t affect me where I’m at. So, the question I have is, and I know the answer, but I want you to answer which is do we really have to factor in climate change when considering buying a home or where to live? And how do you think it would affect those of us work in the industry whether you’re a real estate agent, maybe you work for one of the GSEs Freddie, Fannie, etc?

Sean Becketti
Yeah, I you know, I do you think that really, let’s start with the homebuyer. This the simplest one, it should be a factor for homebuyers is one more factor. Among all the due diligence, you wouldn’t buy a home without having an inspected. You wouldn’t now you should not buy a home without thinking about okay, well, yeah, the structure the they built the home correctly. But you know, what is it going to what is the home going to have to endure? Is it going to, are we going to have greater wind? Are we going to have fires? The one of the things that was sort of troubling that I came across you know, a couple of studies by the National National Association of Homebuilders. They surveyed both home builders and home buyers. About their attitude towards strengthening homes or making them more resilient than is currently required by the building codes. The consumer said, Oh, I believe the building codes are sufficient that if you build up to code, the home should be just fine. And I don’t have I don’t need to take any additional precautions or steps. homebuilders said, Well, we there are things that we could do to make homes more resilient, we can, if you’re in a hurricane region, or we region, there’s going to have more extreme hurricanes, we can we have building techniques that will make it less likely that the siding will be blown off your home or your roof will come off. But consumers don’t believe they need it, and they won’t pay up for it. So we won’t do it, because we can’t recoup the investment. And we’ll only do it if we’re forced by regulation to do it.

Sean Becketti
So it’s just like a catch 22. You know, consumers should say if there’s, you know, if you could convey, we take an extra steps in this home, this home is more resilient than the ones on either side of you, you should pay an extra whatever, 5000 $10,000 Because it’s worth it. We have not been able to build a market around that yet. And that’s that may, you know, as as events become more frequent in certain areas that may pick up but as of today, it doesn’t. The the things that I think are more likely to hit sooner or certainly more the things that I focused on are, how does this complex system of housing and housing finance that we’ve built in the United States continue to function. And the classic example that people start with, because it’s the most frequent risk is flooding. And it’s the most destructive, natural event that we have so far. And we have a National Flood Insurance Program in the United States that’s managed through FEMA, the Federal Emergency Management Administration. It’s been in place for a long time, it was it was originally the the first version of this was put in place with two goals one before. Before a lot of the disaster recovery types of legislation were available, or before this program was available, you got a flood in your area, you were wiped out, you were on your own, wow, well, government decided that, you know, it wasn’t your fault that it flooded, that was a, you know, an act of God. And, you know, we should sort of try to insure ourselves as a nation in pool those risks. And so one of the goals was to have a more efficient way of helping homeowners recover when an event like flooding occurs. The second objective was to discourage people from over building in flood prone areas. That objective is not worked at all, because the National Flood Insurance policies are by law subsidized, so they’re underpriced relative to the risk, which means people to go, oh, great, I have a, you know, an affordable insurance policy, I’m going to build this beautiful house by the ocean, or by this lake or by this river. And if something goes wrong, you know, I’ve got insurance to cover the the effect on me.

Sean Becketti
That’s unfortunate. In addition, as you know, the FEMA produces a Flood Insurance Rate Map the plague, they divide up areas and into areas that are have a specific hazard of flooding, and areas that don’t have a specific flood hazard. And this is all related to this metric that they use called the 100 year flood, which is one of the most confusing terms in the whole thing. 300 year flood, by the way, is expected. This, on average should happen every 26 years within the lifespan of a 30 year mortgage. So yeah, it’s it’s one of those probability questions that fools people all the time. But they’ll they’ll use this to say, Oh, well, you’re, you know, the elevation of your property is above the 100 year flood, you’re not in a flood hazard zone. If you’re below that elevation, then Oh, okay. You’re in a special flood hazard area. In that case, if you have any sort of federal financing like Freddie Mac or Fannie Mae, then you are required by law to have a FEMA style flood insurance policy which you can get from private insurers. But those flood maps are out of date. And the special flood hazard areas are, there’s a consensus that there are a vast underestimate of the areas that are actually at risk. Even even before we take into account the fact that the risk is growing in general that the climate change trend just means more and more areas are becoming flood prone. Yes. So that that means that the system, so the system works, because we’re able to get insurance for these types of things. But the system, the flood insurance system has gone broke before. After Katrina and Sandy, they had reached their congressionally mandated debt limit. And so they couldn’t operate anymore until Congress actually forgave a large billions of dollars of their debt. And so that gave them a little running room. Over time with these later floods and hazards, they’re starting to run out of that running room, and they’re approaching maxing out the amount of debt that they’re legally allowed to issue.

Sean Becketti
If that happens, Congress has to step in again, over the last, you know, eight or 10 years, we’ve been kicking the can down the road because the National Flood Insurance Program has been up for expiration. And instead of doing something, you to overhaul the system, generally, Congress has just sort of said, oh, we’ll extend it for another year, we’ll extend it for another two years. It’s like these budget debates that go on, instead of actually saying, Okay, we’ll spend the money or we won’t spend the money. We’ll just say, Okay, you have another month and a half before we have to deal with this again. And so we’re, I would say, over the last two years, every time there’s a flood, like ITA, a bunch of us in this area, start to say, Okay, what do we think the bill is going to come to? Is it going to push the Flood Insurance Program up to its debt debt limit? If that happens, does that mean that Freddie Mac and Fannie Mae can’t buy your loan anymore? Or, you know, the answer is, we don’t know. So what is the government going to do when it’s faced with that dilemma? Well, in the past, they’ve found ways around it. But at some point, people in Iowa are going to say, Why are you raising my taxes so that people in southeastern Florida can get flood insurance that is underpriced.

Michael Chabot
So that would be one of the real big fixes is to rehaul the Flood Insurance Program and actually have to pay for what it should cost, correct?

Sean Becketti
Well, it’s timely that you mentioned that because just in the last month, they rolled out a, a change that has been in the works for a long time called a risk rating 2.0, which is changing the flood insurance premiums, there’s a cap to how much they can be raised each year. So one one years raise won’t actually get them up to an actuarially fair, premium. But so people are facing multiple one year increases. That, in the past, when they’ve tried to do that, Congress has made them reverse it, because of the outcry from the homeowners, homeowners will be facing insurance premiums that they might not be able to afford. That’ll also, you know, if you’re in one of those areas, that will make your home less attractive for sale, because if you sell it, that premium can reset instantly to the full actuarially fair premium. But we’ll see how this plays out. But it’s it’s a complicated question. And it’s become more complicated by how long it’s been allowed to run.

Michael Chabot
Yeah, and it’s it’s truly a balancing act, because I can see that I mean, I deal with consumers daily, and I could see that you would get to a point real quick for that home. And like you said Southeast Florida would be unaffordable for anybody, right? And it would not be desirable for anybody to purchase it. A couple of stats from your from your study, in regard to the flood insurance and the flood risk. So it says right now currently 40 million people are 12% of the population are in high risk areas. And then a climate risk assessment published by the risky business project. I love that an organization co chaired by Michael Bloomberg, Henry Paulson, Thomas Steyer. Hopefully I said his last name correctly estimated that between 66 billion and 160 billion worth of real estate will be below sea level by 2050. Yeah, that’s a lot.

Sean Becketti
Yeah, it’s, you know, confirmed by studied by others in the union of concerns Scientists looked at chronic flooding a few years ago, came to a very similar, you know, different different dollar numbers because they were looking at slightly different geographies. But yes, really tough situation. And one of the things that you don’t immediately think of, oh, geez, this, these, this is going to cost a lot of money, these houses are going to be, you know, impaired by flooding. But the knock on is the effect on the community. So one of the effects is imagined that chronic flooding becomes more prevalent in a particular community, it’s a significantly more prevalent, you’ll lose values of homes there, you’ll probably lose people who have to migrate out because their home is no longer livable. The community will be trying to raise funds to mitigate all this. At the time when investors say, well, your tax base is shrinking. How are you going to pay back, you know, these municipal bonds, we don’t think this is very good risk. So they’re going to demand a pretty high rate of interest. And so it’s good. You know, it’s a vicious circle, the worse things get, the less you can afford to fix them.

Michael Chabot
Yeah, and I mean, you’re talking off the top of my head. I mean, you’ve got the entire Gulf Coast, that’s got to be at risk, right. We’re seeing more and more flooding, more and more hurricanes. You know, it’s interesting, a, on nameless, but a gentleman, you know, billionaire, he talks about clay, he’s a he’s a climate denier, as you and I talked about before we started recording this. And he’s, he says of climate change are real, they wouldn’t continue to build, you know, waterfront homes and waterfront condos and banks wouldn’t continue to invest in them. I think it’s like you said, and I do have a question coming, which is, do you think they’re just kicking the can down the road or saying, We’ll deal with it when it happens if it happens?

Sean Becketti
Yeah. Before I answer your question in full, there’s an earlier paper I wrote, I brought up the example of an area in the state of Washington called washaway beach. And washaway Beach is an area where it not because of climate change, but because of the hydraulics of the way the Columbia River empties out into the ocean. About 100 feet of shoreline are erased every year. So the original town of that, in that area of washery Beach is now a mile out to see an underwater, they moved the highways, you know, it’s it’s just a natural phenomenon. So beachfront property is actually extremely cheap. I quoted a Zillow comment on a on a home valuation, just like the the they had knocked down the estimated value of this home from $100,000 to $50,000. Because they said, in a couple of years, the home is it’s a manufactured housing, the home will have to be moved, because the ground will disappear underneath. And so people consciously say, you know, I couldn’t afford to buy one of those fantastic mansions in you know, San Simeon or, you know, but, but for three years, I can live on the beach. And for, you know, $40,000 it’s worth it in my dream I can afford a $40,000 investment here. Yeah. Part of it is this kicking the can down the road is a really important part of the puzzle. And one of the I talked to people in who who publish flood scores and risk score climate risk scores. And they one of the things questions I get from them all the time is, why are banks not rushing to buy these scores to figure out what the risk is and the property of their lender gun? And the answer is, the banks have don’t hold the risk. banks sell for most of them, you know, about 60% of the originations for the last couple years enough, because it’s gone up in the pandemic, go directly to Freddie and Fannie and Ginnie, which means that the lender is off the hook, they just, you know, like that. And the only risk they would have is if there’s a servicing issues arise, you know, if the person has to default, but Freddie and Fannie and Ginny are stuck under the rules of the game. It’s got the flood insurance policy, even if Freddie and Fannie think, well, this is under priced and people shouldn’t visit the risk is not really acceptable. By law. They have to buy it that’s in there. Their regulations have, you know, So we’ve kicked the can maybe down the road, we’ve also given the, you know, the hot potato to someone else. You know, the if you’re a developer, your your time horizon is to when you sell the property, not to the, you know, 50 years later.

Michael Chabot
Yeah. And I think it’s interesting because we pass the hot potato to Fannie and Freddie, which is they, they are under still conservatorship as of this recording. Yes. Which means now we’re back with the federal government.

Sean Becketti
You know, if the bill comes to Freddie and Fannie, it’ll come due for each of us, we’ve just will see it in our taxes. Yeah,

Michael Chabot
I agree. And so there are other risks, though, besides flooding, right? There’s, it’s like you said, extreme climate change or heat waves where it gets maybe too hot, where you can’t have people work outside. Other precipitation events,

Sean Becketti
wildfires for us, I win, ya know, all those things. And, yeah, and then the loads, we’ve talked about the associated changes in, you know, what’s viable for certain areas? You know, we large part of the, you know, well, California is a really good example, California has been, you know, like an agricultural wonder for centuries. And that’s getting tougher and tougher to do the persistent drought in California is really hurting a lot of the agriculture hurting almonds, hurting wine vineyards, on and on. So it’s, it’s tough.

Michael Chabot
Yeah, I mean, California, I know, I still look at a lot of the things a lot of their lakes are the lowest they’ve been maybe ever or in hundreds of years, you know, since they started recording these things. So it’s real.

Sean Becketti
I’ve driven by Shasta, and it doesn’t look good.

Michael Chabot
No, Shasta is one of the lakes that I was thinking of. Yeah, it’s it’s pretty low. And it’s, it’s alarming for sure. You know, we can talk about there’s a lot of things we can talk about, I think we’ve covered it the risk for urban areas, right with with climate change. We’ve talked about residential property damage, what we didn’t really talk about is mortgage defaults when these type of things happen. And what does it mean for you know, because I think you’ve touched on it, but what it means for consumers, if you have mass areas of destruction and mortgage defaults, it’s not good for your community, as we saw, really in 2007 2008, right, that was a different issue. But I’ll stop talking and let you expand on that. Sure. Yeah.

Sean Becketti
There’s certainly evidence that, you know, people, especially people in areas that are just outside the insurance areas, so if you’re, if you’re across the street from the Special Flood Hazard Area, you probably didn’t pay up for an insurance policy, but you’re pretty close to having the same risk. And so uninsured people tend to have a higher probability of default after one of these events. Another factor, which, you know, some hedge funds are starting to bet on is, they feel that because people have underestimated the potential risk, that some of these properties are overvalued. And as people come to the conclusion that they’re overvalued, one way they’ll come to the conclusion is rising insurance premiums, you know, if this risk rating of 2.0 stays in place, all of a sudden, people say, well, the cost of owning this home is going up, that means it’s worth less, you know, it’s just worthless to me. And if there’s an adjustment there, you know, we know that when people I think I wrote in earlier papers, like, you know, we know that people who have underwater mortgages are more prone to default, they’re more prone, especially if they have underwater homes. But in addition to so that’s one of the things I wrote about in the study, is the challenge. If you are at Freddie or Fannie, or you’re a large portfolio lender, okay, what is my new risk of default? You know, I have a set of traditional models that look at the borrower’s credit worthiness, and I look at the trajectory of home prices. And then I sort of say, Oh, well, you know, here’s, here’s what, you know, out of this 1000 homes in this area, you know, this many I think are going to run into trouble and we’ll actually go all the way to default and this is going to be my cost and I put in a loan loss reserve for that. This is really hard to do. It’s it’s hard to convert You know, rainfall estimates or flooding estimates into dollar loss. Few organizations have tried to do that. And there’s still early days, we don’t know how reliable those estimates are. And but we do see that people that do take these hits exhibit a higher rate of default. You know, the, the GSEs have always said, you know, we’re not concerned about this too much, because of the insurance, the National Flood Insurance in those areas. Because historically, they have been de minimis events for us. We have not lost a lot of money, people, people in areas that that get flooded, but they have insurance. Go delinquent? Almost certainly. And then the agencies give them forbearance. And in six to 12 months, they cure, they get there, they finally get their insurance money from the government. They fix their house, they get their work life back in order they catch up. People outside those, don’t they default? Yeah. But you know, you’re talking about how this invisible mortgage finance system works. The other thing that people care about is, people in the insured areas, prepay more, or after an event prepayments go up. So if you’re an investor in mortgages, one way or the other, or if you’re a mortgage servicer, you really care about this, this affects your profitability a lot. And so it makes the whole question of predicting predicting prepayments and defaults. Just that much harder.

Michael Chabot
Yeah, do you think in your opinion, we’ll see higher interest rates in those high risk areas to maybe cover some of this risk?

Sean Becketti
So not as long as we can sell loans to Freddie and Fannie? Is one of you know, as long as the music keeps playing, you know, we’ll, we’ll keep doing this. But now, the question is, what, what does the future or what is the end game look like for certain areas? You know, will we start recognizing the costs? Will people migrate out of areas or into areas based on climate? Very difficult to predict? You know, I tend to think that when you look at Think of housing price bubbles, often we think, okay, houses are overvalued, we certainly thought that bleeding into 2007 2008, we were worried about it for a long time going in, yet they kept going up. And so every day, you could say, well, it’s not happening today. And, you know, I don’t, I don’t want to back out of this market too soon, you know. And so, and then one or two events happen, and it’s a catalyst for a sudden break. Yeah, that’s certainly one scenario that could happen in these areas that, you know, all of a sudden, somebody finds they can’t sell their home, that panics everyone else is trying to sell, and it just feeds on itself. That there’s a lot of vigorous debate over whether that type of scenario will play out, there’s a lot of people will go, like, that’s just that’s just not what’s gonna happen. They might be right, they might play out totally differently. But it’s something you know, things do, we’ll reach the breaking point, some at some point. So something has to happen before then change in policy, you know, change in, in the way we build structures, the way we retrofit structures.

Michael Chabot
Yeah, and I agree with you, I mean, you can only you can, it’s really about risk and reward, right? It’s risk reward, meaning, you know, if you’re a home buyer or home seller, if you’re a lender, you’re GSE. It’s all about risk and reward. Let’s transition a little bit into you talk about client mitigation efforts in the study. What does this mean, and what are those efforts?

Sean Becketti
Sure. This is, you know, I often talk about sort of what would make you feel optimistic or pessimistic about our ability to manage climate change? And, you know, if you start reading about the science of how climate is changing, it’s very easy to scare yourself and say, Oh, my gosh, these are these are really large global problems, and they’re expensive, and we don’t know how we’re going to deal with them and, and you could be really discouraged. Then you start thinking about, Oh, well, there are a lot of ways that we can technically address these problems and then you start to feel very optimistic. And Elizabeth, I’ll talk about a couple We’ll have those in a second. Then you say, Well, wait a second, those are expensive and, you know, adopting those, you know, would disadvantage, some very powerful industries that have lots of money to lobby the government or stall things such as we’ve seen. And then you can start to get pessimistic again. And I think the lady where I ended up is on the optimistic side, because this is one of the nice features of hedge funds is that they’re starting to really put the heat on companies that are not recognizing the risks they’re facing, and changing valuations getting board seats on energy companies. I think we’ll see that happening in housing as well. But back to your your question on mitigation. The number one, right, global warming is because of the increase since the beginning of industrialization in the concentration of greenhouse gases in the air. So the answer is really simple. You have to reduce the amount of greenhouse gases in the air. It’s simple, but now how to do it is really complicated. And, and steps on a lot of people’s toes. So number one, you can’t keep burning more and more fossil fuels and just releasing the results into the atmosphere, that that’s not a solution. That’s, that’s just makes things worse. So you, you want to look for energy sources that don’t do that. And the number one opportunity that people see is electrification, use electricity for more things, that currently has a downside, and that a lot of electrical plants actually burn fossil fuels to generate electricity, coal fired electrical plants, but that’s changeable. And some of it depends on improvements in battery technology, because you need to store electricity to be available when you want it. That’s, that’s possible. But you know, as we see the the administration’s plans for climate mitigation are being held up in Congress by one person who comes from a state that specializes in coal. So this is not going to be an easy thing to do it. And it’s you know, I certainly don’t mean to make light of the challenge of anyone who’s invested in a fossil fuel industry, you know, they didn’t knowingly create climate change. They’re doing what they’re doing, because we need fossil fuels currently. But we somehow have to find a way to move past that to how we’re going to transition to something else. And that’s not going to be easy to navigate. But if we can, so how can how can we take greenhouse gases out of the atmosphere, reforestation, which actually was in the news last couple of days, because Glasgow is a very effective way to remove carbon, at least from the atmosphere. Unfortunately, the world’s been going the opposite direction, not only just the natural growth in development is population growth. But Brazil in particular, which has one of the largest forested areas in the Brazilian rainforest is notorious for deforestation at an increasing rate. And it’s very difficult to negotiate a change in that, given the internal politics of Brazil. Farmland can be modified. This is a something that’s really appropriate for the United States. Tree planting a to demarcate areas of farmland ways of changing drainage ways of changing the crops that you cycle through.

Sean Becketti
There’s techniques that at fairly low cost can improve the ability to to trap carbon from the atmosphere and stored in the ground. And actually carbon in the ground is a positive thing for agriculture. The there’s a plant that opened in the last couple of months in Iceland, it’s been developed for a while that actually scrubs carbon directly from the atmosphere. Just think of it as the same type of technology that we use to trap pollutants in smokestacks before they’re emitted. This is a demonstration project. It’s not an doesn’t trap enough carbon to make a difference. But what they’re trying to figure out is how can we scale this in an economically efficient way right now, it’s just not economically efficient to apply Technology. Biofuels are a possibility. Those are all, all things that can be tried. And there are many, many more cars. The you know, we do what we can with, with climate mitigation, which is making climate less hazardous than it would have been otherwise. Beyond that, we have to think about climate adaptation. I’m just gonna get worse. Yeah, I’m it’s gonna get worse. So how are we going to survive it? And yes, there are all sorts of innovative and interesting techniques, there’s a project in New York, for So, overtime development in New York has eliminated what used to be a thriving oyster bed in the New York Harbor. It’s changed the structure of the shoreline, it’s eliminated a lot of what had been natural barriers to storm surges. So the storm surges are more intense now, without climate change. And some innovative landscape. Architects have proposed plans for restoring some of those natural barriers to the destructive storm surges. There’s a thing called the Billion Oyster Project in New York, they’ve about repopulating that oyster industry. You know, oysters are great, because they not only build up these areas that soften the blow of incoming storm surges and waves, but they also clean the water and take the pollution out. So they’re very effective, if you can re establish them as low cost. In housing itself, there are lots of different techniques that you can use to strengthen the house to make it more resilient. One of the things that people are exploring is what they call passive cooling techniques. So that think of before air conditioning was widely available, you had to make the your house as cool as it could be, however, you could. So techniques that use thicker exterior walls that optimize certain types of airflow within the house, that often that had that central courtyard where you could disperse heated air, and then a lot of those things can be used to try to reduce our load on the power grid.

Michael Chabot
So I think what’s, what’s a positive that comes out of all of this is that, for those that are are ambitious, and smart, and industrious, there’s whole new business ventures out there to help not only, you know, build a business and be profitable and successful, but to help change the United States and the world. Yeah, that’s exciting.

Sean Becketti
Yeah, no, it is interesting to see how many people are organizing around this, either through volunteer efforts, which are great. But also like, oh, I can make some money doing some good. Yeah, right thing to do.

Michael Chabot
So win win. And so real quick, going back to the greenhouse gases, I learned recently, I read another book on climate change. And I didn’t realize this that one of the biggest contributors to methane gas in the atmosphere is food waste. Yes. Yes. That’s amazing. Yeah. I mean, you would think that would be something we could easily fix.

Sean Becketti
Yeah. And, you know, food waste when you think about it, we have large swaths of the population that don’t get adequate food period. Your food waste seems like such a terrible thing. When other people are hungry, but yeah, yeah, no food waste. Yeah.

Michael Chabot
So I want to ask you a question. And it’s, it’s, it’s not meant to be a political question. It’s really just your opinion. And this is not in our list of questions. You know, we can do everything around the world. But I’ve read and you can correct me if I’m wrong, that China and India are some of the worst polluters in the world. As far as, and I think, correct me if I’m wrong at the recent summit that they just had, they chose not to show up. Was it just China or both China and India? I don’t recall. It was China and Russia. It’s China and Russia. Excuse me. Okay. So my question to you is, let’s say that every other country in the world, you know, starts working on these mitigation techniques, but we let’s just say some of these other countries do not can we make a difference still if they choose not to get on board, in your opinion?

Sean Becketti
Yeah, no, I That’s an excellent question. I, I don’t think the fact that some countries will lag behind is an excuse for not doing what you can. The you know, it is one of those things about climate change until As you can’t stop it at the border, it’s just traveling. And you will want to get as much global cooperation as you possibly can. As we’ve seen, this is just really difficult to accomplish. Yeah, there. We look at the center the history of the past century or two, and look for episodes where the globe cooperated. I would say that the one where, you know, as bumpy as it’s been global cooperation during the pandemic has been heartening, then you know, it’s true, it’s not perfect. It’s true that, you know, the more affluent countries have taken a larger share of the available vaccines. It’s true that not every country is with the program. And you really do need everyone to get with the program, if you hope to reduce the spread of such an infectious disease. But overall, the world’s not done that terribly at cooperating in the face of, you know, a very contentious, hotly debated, and very politicized issue. And it’s done better than you might have expected at the beginning. I think the with climate change summit, I feel that we will take it more seriously as time goes on. The question, in my mind is, will we do it soon enough? Usually, we, we don’t. You know, I read just a year or two ago, one of the biographies of Franklin Roosevelt during the Warriors. And how, even though, you know, the the risk of war kept growing, and clearly the situation in the access countries was, was pretty well understood. You had such a sentiment for isolationism in the US that preparing for war was not allowed was not, we weren’t able to do prayer prepare in the way that we probably should have. And as a result, we did really badly in the first, you know, six months of the war, we had horrific losses, and we were working at a disadvantage, that could have been avoided. I think climate change is the same sort of thing where it’s only when the risk and the damage is just undeniable, that you’ll see that sort of cooperation. At that point, the effort to turn things around and to mitigate, will be that much tougher, and it will be harder to do. So I don’t think that we won’t get it done. But I don’t think it’ll be a pretty process.

Michael Chabot
Well, and I would say, excuse me, somebody has to lead the way. So why not us? Yeah, right. I think every country should feel that way. And I think we’re getting close to what you’re just talking about. I mean, we just saw flooding in Sicily, right, you’re seeing more and more weather events or climate events around the world. And so I want to be respectful of your time, this time has flown by, we could probably do five hours and not even touch at all. I just kind of want to put a bow on all of this stuff. You know, what do you think this means moving forward for consumers homebuyers. And then on the flip side, you know, lenders, mortgage servicers, you know, we could you know, we could throw in the GSEs, Fannie, Freddie, you know, builders, realtors, just kind of, you know, where do you think we go from here? How do we move forward?

Sean Becketti
Right. I think the physical risks are, are easier to get a grip on for most people, if you see them, you know, sort of what things cost, you know, how it affects your life. And I think, you know, we will somehow figure out a way to, to manage through that. I think the I think there’s big changes that they’re trying in the National Flood Insurance Program, they’ll have to try some more, Congress will have to grapple with some difficult questions. I think the thing that makes housing different than other industries in facing climate risk is the complex system of finance that makes the housing system and you in the US what it is, and that we, you know, if owning your own home is the American dream, as we often say. We’ve constructed a really complicated interconnecting system to support that. And that system is not built to sustain The pressure of climate change. And so that’ll be hard to sort out it’s in, I think is harder to get people to engage in that because it’s opaque to so many people. It’s it’s a specialist topic,

Michael Chabot
of course. Do you think that’s so just to kind of break it down? In layman’s terms for those listening that are consumers? Do you think it’s because are you saying, you know, you have a lender or who originates loan, you know, gives that consumer loan, they move in their house, now that loan is sold to let’s say, Fannie or Freddie? Sure. And then you have a separate company that’s servicing it. Yeah. So you have just so many layers, right? Do you think the solution is to try and simplify it, maybe have have lenders retain the servicing or retain more of the risk?

Sean Becketti
That Well, we’ve certainly talked about it, I mean, QM was, you know, an idea to like, make sure that everyone had some skin in the game. There are definitely ways to think about reallocating the risk, we invented this system over time, we can modify it, you know, it doesn’t have to stay the way it is. And, and we can do that, in a way that’s actually fair to all the people that are bearing the risk now that they can, you know, be part of this, this solution. But I think, just, you know, sort of burying your head in the sand and hoping that it doesn’t get too bad is probably not going to be a good strategy.

Michael Chabot
No. Yeah. And and correct, correct me if I’m wrong, this system was born out of the Great Recession, when the stock market crashed, there was a run on the banks back in those days to savings and loans, or they actually held your mortgage against their deposits. There was a run on the bank, they had to call all the notes, lots of foreclosures. So they created things like FHA, you know, HUD, and Freddie, etc, correct.

Sean Becketti
It took decades to get this system, you know, and it was, you know, each thing we tried, we would see what worked and what didn’t work, and then we have to make some other adjustments. Now, it’s a great system. It’s it’s made, you know, life in the US have some real advantages over what might be available elsewhere. You know, you look at other developed countries that don’t have the same rate of homeownership. Homeownership has been a great way for people to build wealth for an ordinary working class family to really build a substantial wealth over time. I agree. We’d like to be able to sustain that.

Michael Chabot
Yes, well, Dr. Piketty, I have it’s been such an honor to take this hour with you. We’re gonna make this study available in the show notes. And I’d love in the future to have you back because we barely scratched the surface on this thing. There’s a lot more to do here.

Sean Becketti
Glad to do thank you so much for having me on.

Michael Chabot
Yeah, it’s been an honor and guys, those of you watching and listening, if you’ve liked this, please share it like it. Tell your friends about it. Again, I’m your host, Michael Chabot. This is Your Mortgage Matters brought to you by Angel Oak Home Loans, and we’ll see you again real soon.