The collapse of Lehman Brothers in 2008 was symbolic of a deep global financial crisis, centered on the housing bubble and subprime mortgages.
Increasing natural disasters are straining insurance companies, leading to policy cancellations, rising premiums, and ultimately falling property prices.
More and more areas in the U.S. are losing their insurance coverage, which in turn is affecting the ability to finance housing, as without insurance, mortgages cannot be issued. This chain can lead to gradual economic destabilization, with banks abandoning areas and entire communities becoming economically disadvantaged.
While there is still no consensus on whether the climate crisis could trigger a new financial meltdown like the one in 2008, many experts and institutions are warning of a growing, structural risk.
The problem is that, unlike past crises that were overcome with policy measures, the threat of climate change is one-way and long-term. If disinvestment in insurance coverage and lending from high-risk areas continues, then the overall value of the real estate market will begin to erode, affecting the stability of the financial system more broadly.
All it takes is a permanent, gradual shift to undermine the economic basis of housing as an asset.
Memories
Anyone over the age of 40 likely remembers September 15, 2008, the day Lehman Brothers collapsed. It was one of the first of many shocking moments during the last global financial crisis, a traumatic period of bank failures, bankruptcies and liquidations as major economies plunged into some of their deepest slumps since the Great Depression.
The devastated Lehman employees, who left the offices of the 158-year-old investment bank carrying their belongings in cardboard boxes, symbolized the millions who lost their jobs, homes and savings in a disaster that wiped out trillions of dollars in wealth.
Who was to blame
There were many culprits for the turmoil, but, as in many previous financial disasters, the housing market played a major role. In 2006, the US housing bubble burst, driven by supposedly safe mortgage-backed securities sold worldwide, including risky subprime mortgages.
As delinquencies and foreclosures mounted, the value of these securities collapsed, leaving investors with crushing losses and sending financial markets into a panic. In the months following the crisis, government bailouts and sweeping reforms began to repair the battered financial system.
Today, the big banks are better capitalized. Markets are better regulated and investors are better protected as a result of these reforms. And yet, each month now brings warnings with echoes of that turmoil.
Concerns are growing that housing markets could be disrupted again, this time not by risky lending practices but by the increasing frequency of climate-related disasters that are putting pressure on insurers and other critical financial institutions.
“Real estate values will eventually fall — as they did in 2008 — sending household wealth into a tailspin,” said the December Next to Fall report on climate change and insurance from the then-Democratic Senate Budget Committee (“Νext to Fall: The Climate – Driven Insurance Crisis is Here – And Getting Worse“). “The United States could face a systemic shock to the economy, similar to the 2008 financial crisis — if not greater.”
The warnings
In January, the Financial Stability Board, which was set up to monitor the global financial system after the 2008 crisis, said that insurance was becoming increasingly expensive and scarce in disaster-stricken areas and that “climate shocks” could cause broader market turmoil. In early February, Federal Reserve Chairman Jay Powell warned that the Fed was seeing banks and insurers withdrawing from risky areas.
“If you look 10 or 15 years ahead, there will be areas of the country where you won’t be able to get a mortgage. There won’t be ATMs [and] banks won’t have branches,” he told Congress. “I don’t know if this is a financial stability issue, but it certainly will have significant economic consequences.”
Less than two weeks later, Warren Buffett told shareholders of his Berkshire Hathaway conglomerate, which includes a number of insurance companies, that property insurance prices had risen because of a sharp increase in storm losses. “Climate change may have announced its arrival,” he said. “At some point, on any given day, a truly catastrophic insurance loss will occur — and there is no guarantee that it will only happen once a year.”
Then, as Europe experienced its hottest March on record, Günther Thallinger, a member of the board of directors of German insurance giant Allianz, warned that global temperatures were rapidly approaching levels where insurers would no longer be able to operate, creating “a systemic risk that threatens the foundations of the financial sector.”
“If insurance is no longer available, other financial services will also become impossible,” he wrote in a headline-grabbing LinkedIn post. “The economic value of entire regions — coastal, arid, fire-prone areas — will begin to disappear from financial books,” he added. “Markets will revalue, quickly and violently.”
The Chain of Consequences
There is no single scenario for exactly how the cost of home insurance could lead to financial turmoil due to climate. But here is one that has emerged from conversations with more than 20 investors, financial analysts, regulatory experts, insurance executives, scientists and researchers.
It starts with the increasing withdrawal of insurance companies from American states, which has gone from a trickle to a flood, and not just in disaster-hit areas like California. Across the country, homeowners are facing rising premiums or the inability to renew their coverage as insurers grapple with a relentless series of wildfires, storms and hurricanes.
Fiscally strapped governments are trying to fill the gaps with more emergency insurance programs. But these plans typically cost more and cover less, creating a troubling new reality for thousands of homeowners. The value of their family home, which had been rising year after year, is starting to fall.
The “contagion” is spreading because you need insurance to get a mortgage, so as homeowners’ coverage disappears, so does the bank’s presence. In state after state, it’s becoming impossible to find a bank branch. Some lenders are dropping out altogether.
The Role of Real Estate
It must be said that opinions are far from settled on whether global warming will ever cause this or any other form of financial turmoil.
Climate change is real, but it may be too early to say that it poses a serious risk to the safety and soundness of major banks or the financial stability of the United States. For example, real estate values have collapsed after the population of U.S. cities like Detroit has declined, without jeopardizing financial stability. Why should declines in coastal cities hit by rising sea levels be any different?
Also, the Fed’s stress tests, which typically assume a decline in U.S. real estate prices of more than 25%, had shown that the largest banks could absorb almost $100 billion in losses on loans secured by real estate, plus another $500 billion in losses on other positions.
Even experts who disagree and believe there is a climate-induced insurance problem are not saying that it will automatically lead to sudden crashes like the 2008 financial crisis.
Here’s how former California insurance commissioner Dave Jones, a Democrat, put it: “Over time, you’re going to see more insurance company insolvencies, more insurance price increases and less insurance availability, more loan defaults and declines in asset values and credit freezes, rather than a single catastrophic event or events where a series of financial institutions nationwide collapse at the same time.” However, he added, “There’s some risk to that as well.”
Natural Hazards
Meanwhile, signs of natural hazards from climate, which initially seemed more remote than the risks of transition, have become increasingly apparent.
- Heavy rains brought Dubai to a standstill in April last year and forced thousands of people to evacuate areas in China.
- Hundreds of people died a few months later when Typhoon Yagi hit Southeast Asia.
- In October, authorities in Florida were still dealing with the debris left behind by two massive hurricanes that hit the state in an unusually short period of 13 days when devastation struck the Spanish province of Valencia.
- More than 200 people died when a torrential downpour dumped the amount of rain expected in a year in a few hours.
- Less than three months later, the world watched as massive wildfires wreaked havoc in the Los Angeles area, killing dozens and destroying thousands of homes, including the mansions of Hollywood celebrities.
- The pace of destruction continued this year.
- In March, South Korean leaders said the deadly fires sweeping the country were the worst in the nation’s history, while Japan ordered thousands of people to evacuate due to its worst wildfires in decades.
- Massive wildfires have forced thousands of Canadians to evacuate, and Australia has been hit by a devastating series of floods that officials say are affecting economic growth.
- This month, authorities issued extreme temperature warnings across North America, Europe and Asia.
- There is no sign of abating in a warming world.
- Last year, for the first time, global average temperatures reached 1.5°C above pre-industrial levels for 12 consecutive months.
- Sometime in the next five years, temperatures are likely to rise by almost 2°C for the first time, scientists said in May.
None of these events have caused systemic financial instability. Trump’s disruptive tariffs have had a much greater impact.
However, the growing number of disasters has begun to change the way experts look at climate-induced financial problems.
What we have seen with the Los Angeles fires and other unexpectedly devastating disasters is that we are already at a point where natural hazards could pose a threat to the financial system.”
Dormant assets
Banks have been doing a similar review, as for years it was thought that dormant assets and other transition risks would be the biggest threat, but the scale of extreme weather disasters in recent years has forced a review, as it shows that natural risks are intensifying much faster than initially expected.
The fact that the intensity of extreme events is increasing at a rate we did not previously understand, and this is affecting an asset class as large as real estate, could leave lenders exposed to uninsured properties that will fall in value. If we were to look anywhere in the world for something that could cause a financial crisis, that would be where we should focus most.
Four days before Donald Trump’s inauguration on January 20, the U.S. Treasury Department’s Federal Insurance Bureau released what it called the most comprehensive data on homeowners insurance ever compiled (“U.S. Department of the Treasury Report: Homeowners Insurance Costs Rising, Availability Declining as Climate-Related Events Take Their Toll“). Its analysis, based on 246 million policies issued between 2018 and 2022, showed that insurance was becoming increasingly expensive and less affordable for millions of Americans, especially those living in areas at increased risk of natural disasters.
The average cost of insurance for people living in areas where the greatest losses from climate-related events were expected was 82% higher than in less-risky areas.
Dangerous Locations
Those in more dangerous locations also experienced much higher rates of non-renewals, where insurance companies refuse to renew homeowners’ policies.
The report included information from agencies such as the National Oceanic and Atmospheric Administration and the Federal Emergency Management Agency (FEMA). Both agencies have come under pressure from efforts to cut the federal workforce, and Trump has announced plans to begin phasing out FEMA.
The Federal Insurance Office would also be eliminated under legislation introduced by a Republican congressman in January, which would leave U.S. states as the sole regulators of the insurance industry. The move was supported by insurance executives, who called the January report “problematic” because it focused too much on climate change, ignoring other factors that drive up insurance costs, such as inflation, lawsuits and the movement of people to dangerous areas.
Other insurers point out that while extreme weather events are significant, most have coincided with rising house prices, which has so far acted as a significant cushion against mortgage defaults. As for the risks to the insurers themselves, industry executives are quick to point out that they typically offer coverage for a single year, not decades like bank mortgages, so their financial exposure is more limited.
At the same time, efforts are being made to reform insurance markets to make them more resilient to climate risk, to encourage homeowners to build in less hazardous areas, and to strengthen the resilience of existing homes to extreme weather events.
The Efforts
We must hope that these efforts will pay off. But we must also recognize that many of them are based on data, analysis, and shared expertise about the impacts of climate change — data that is now under serious pressure in the United States.
A day after the Federal Insurance Office published its report in January, the Federal Reserve announced that it was withdrawing from the Network for Greening the Financial System, a network of central banks that has led many initiatives to address climate-related financial instability.
Two weeks later, the Federal Insurance Office announced that it was also withdrawing from the same network, in accordance with presidential executive orders on “Putting America First in International Environmental Agreements and Unleashing American Energy.”
As Brooke Rollins, the president’s secretary of agriculture, later told Fox Business: “We’re not doing this climate change nonsense anymore.” That’s because, she said, “it’s a new era.”
