Climate change could cause a new mortgage default crisis

Small floods will hit an expanding share of houses every couple of years

Gillian Tett 

People float down Lakeshore Drive in Mandeville, Louisiana, which is covered by water from Lake Pontchartrain after flooding in the aftermath of Hurricane Barry in July © Getty

This week Greta Thunberg, the teenage activist, stole the show at the UN General Assembly meetings in New York with an impassioned plea for urgent action on climate change.

It was electrifying. 

However, if investors need a further reason to wake up, they should take note of another event: the release by a UN-supported entity, called Principles for Responsible Investment, of a report warning that “financial markets today have not adequately priced-in the likely near-term policy response to climate change”.

Indeed, the PRI — whose membership includes some 500 global asset managers — predicts a market “response by 2025 that will be forceful, abrupt and disorderly because of the delay”. 

In plain English, they expect a market shock.

And if this sounds too abstract to be meaningful, Dickon Pinner, a McKinsey consultant, gave the UN a couple of examples of where “disorderly” repricing might occur. 

Coastal regions such as Florida, he warned, could deliver asset price shocks for lenders, insurers and homeowners. 

So, too, in places such as Spain, southern France, Greece and Italy which are projected to see eye-popping increases in drought.

Meanwhile, the analysis circulating in the halls of the UN this week was even more startling. 

Jupiter, a climate advisory group, for instance, recently showed me the type of modelling it is performing for banks and insurance companies in the US. 

Using a synthetic portfolio of 100,000 residential mortgages in southern Florida — based on the exposure of a real bank — Jupiter forecasts a tripling of losses from flood damage in the next couple of decades.

This is partly due to the rising frequency of headline-grabbing weather events, like hurricanes. 

But the main reason for projected losses is the increasing chronic risk, such as floods that are less than one foot in depth but which will be hitting an expanding share of houses every couple of years.

This will hurt insurance groups. 

It could also be devastating for some homeowners: while American households typically use 30-year mortgages to buy properties, the price of insurance is reset annually. 

There is, in other words, an embedded maturity mismatch in risks in the Florida property markets that could spark mortgage defaults, hurting borrowers and lenders.

“This is not priced into markets,” says Rich Sorkin of Jupiter. 

Or as Hans Helbekkmo, an analyst from McKinsey, observes: “Based on this Jupiter analysis, our own analysis suggests that we could see loss rates [from mortgage defaults] similar to the 2007 [subprime crisis] in the next 10 to 20 years.”

But equally shocking is how complacent many investors and politicians still appear to be about these risks. 

Part of the problem is that politicians rarely want to break bad news to voters voluntarily.

Another issue is that the finance industry and policymaking circles today are plagued by the same structural patterns that prevented most investors from understanding the dangers posed by subprime mortgages more than a decade ago. 

Today, a small number of insurance experts and climate change scientists understand the risks. 

So do some savvy financial players, including hedge funds.

But most ordinary investors have little grasp of the full implications, because climate science — like mortgage derivatives — is technically complex. 

Even professional asset managers struggle to work out the probabilities embedded in insurance forecasts. 

The result is extreme information asymmetry.

Worse still, silos inside financial institutions and government agencies impede rational planning. 

And the long-term nature of the problem leaves some investors assuming that government bodies such as the US Federal Emergency Management Agency will create a safety net. 

This complacent assumption is probably as flawed as the widespread belief before the 2008 crisis that federal institutions in America would protect mortgage markets from shocks.

So how will this end? 

It would be nice to think that the work by the PRI and others will now prod investors, insurers and banks into the type of timely action that would enable asset prices to adjust smoothly. 

It would be even nicer if governments heeded Ms Thunberg’s appeal and tackled climate change, as well as becoming more honest with voters about what lies ahead.

But don’t bet on this happening. History shows that extreme information asymmetries produce market shocks. 

That’s what happened in the subprime mortgage saga. 

It is hard to believe it will be any different with climate change.

Beware Economists Bearing Policy Paradigms

US President Joe Biden's administration has embarked on a bold and long-overdue departure from the economic policy orthodoxy that has prevailed in the US and much of the West since the 1980s. But those who are seeking a new economic paradigm should be careful what they wish for.

Dani Rodrik

CAMBRIDGE – Neoliberalism is dead. 

Or perhaps it remains very much alive. 

Pundits have been calling it both ways these days. 

But either way, it is hard to deny that something new is afoot in the world of economic policy.

US President Joe Biden has called for a vast expansion of government spending on social programs, infrastructure, and the transition to a green economy. 

He wants to use government procurement to rebuild domestic supply chains and bring manufacturing jobs back to the United States. 

His Treasury Secretary, Janet Yellen, is pushing for a globally coordinated increase in corporate taxes. 

Jerome Powell, Chair of the Federal Reserve, traditionally the most hawkish arm of government on price stability, is playing down inflation fears and lending his support to fiscal expansion.

All of these policy changes represent a sharp departure from the conventional wisdom in Washington. 

Do they also augur a new economic policy paradigm?

Economic policies in the US, and the West more broadly, have long been in need of overhaul. 

The ideas dominant since the 1980s – variously called the Washington Consensus, market fundamentalism, or neoliberalism – originally gained traction because of the perceived failures of Keynesianism and excessive government regulation. 

But they took on a life of their own and produced highly financialized, unequal, and unstable economies that were unequipped to cope with today’s most significant challenges: climate change, social inclusion, and disruptive new technologies.

The needed paradigm change might usefully start with how we teach economics. 

Economists tend to be enamored of the power of markets to promote overall economic prosperity. 

Adam Smith’s invisible hand – the idea that self-interested individuals seeking only their personal enrichment might produce collective prosperity instead of social chaos – is one of the crown jewels of the economics profession. 

It also remains deeply counterintuitive, which is perhaps why economists devote an inordinate amount of time proselytizing about the magic of markets.

But economics is not a paean to free markets. 

In fact, much of economics instruction focuses on how markets may produce too much inequality, and how they fail on their own terms of allocating resources efficiently. 

Perfectly competitive markets that harmoniously produce stable equilibria are only one possibility among many. 

The Smithian model is not the only one. 

Still, the knee-jerk reaction of many economists is to treat well-functioning, competitive markets as the relevant benchmark for any proposed departure from laissez-faire.

Fortunately, a new paradigm for teaching economics does exist. 

The CORE Project is an online teaching tool and free, open-access textbook. 

Two leading economists, Samuel Bowles of the Santa Fe Institute and Wendy Carlin of University College London, are the visionaries behind it. 

But a large group of economists worldwide has collaborated in its development. 

Already, it is in use in a majority of university economics departments in the United Kingdom.

A key advantage of the CORE approach is that it tackles issues like inequality and climate change head-on. 

But the pedagogically more interesting move is that it replaces the standard benchmarks of economics with alternative benchmarks that are more realistic and useful. 

For example, in contrast to conventional economics, CORE assumes that individuals are pro-social and myopic, rather than selfish and far-sighted. 

Competition is imperfect, with winner-take-all characteristics, rather than perfect. 

Power is ever-present in the form of principal-agent relationships in labor and credit markets, instead of being treated as either diffuse or exogenous. 

Economic rents are ubiquitous and often required for well-functioning economies, not rare or the result of policy error.

Such a new paradigm for teaching and doing economics will produce better understanding of social outcomes. 

But we should recognize that it will not produce a new paradigm for economic policy. 

And that is as it should be.

All of our previous policy paradigms – whether mercantilist, classical liberal, Keynesian, social-democratic, ordoliberal, or neoliberal – had important blind spots because they were conceived as universal programs that could be applied everywhere and at all times. 

Inevitably, each paradigm’s blind spots overshadowed the innovations it brought to how we think about economic governance. 

The result was overreach and pendular swings between excessive optimism and pessimism about government’s role in the economy.

The right answer to any policy question in economics is, “It depends.” 

We need economic analysis and evidence to fill out the details of what the desired outcome depends upon. 

The keywords of a truly useful economics are contingency, contextuality, and non-universality. 

Economics teaches us that there is a time for fiscal expansion and a time for fiscal retrenchment. 

There is a time when government should intervene in supply chains, and a time when it should leave markets to their own devices. 

Sometimes, taxes should be high; sometimes, they should be low. Trade should be freer in some areas, and regulated in others. 

Mapping the links between real-world circumstances and the desirability of different types of interventions is what good economics is about.

Our societies are confronted with vital challenges that require new economic approaches and significant policy experimentation. 

The Biden administration has launched a bold and long-overdue economic transformation. 

But those who are seeking a new economic paradigm should be careful what they wish for. 

Our goal should be not to create the next ossified orthodoxy, but to learn how to adapt our policies and institutions to changing exigencies.

Dani Rodrik, Professor of International Political Economy at Harvard University’s John F. Kennedy School of Government, is the author of Straight Talk on Trade: Ideas for a Sane World Economy.

Prepare for a ‘supercycle’ in anti-mining activism

New waves of social opposition set to hit the industry may change it for the better

Daniel Litvin

Cobalt metal nuggets from a copper mine in Zambia. Climate activists, who have tended to target the energy industry, are now turning their attention to mining © Bloomberg

For decades miners have been a favoured target of anti-corporate activists. 

The environmental and social impacts of mineral extraction have created rich pickings for campaigners, while the industry’s claims to bring big benefits to host countries have often met with scepticism, whatever their merits.

Now, as the sector is being revived by soaring commodity prices, if faces a set of societal forces that promise an even stronger onslaught — albeit one which may shift the industry to a better standing in terms of environmental, social and governance credentials.

The first is a mounting backlash against the industry’s narrative of climate-friendly materials. 

With the energy transition expected to provide a boost for demand of key materials for a cleaner energy infrastructure like copper, cobalt and lithium, many miners have trumpeted their green credentials.

But this has prompted the industry’s longstanding critics to hit back. 

In March, for example, War on Want published an analysis highlighting what it saw as the “potential widespread destruction and human rights abuses” unleashed by the extraction of such minerals. 

In April, a study supported by Earthworks called for recycling to reduce the need to mine those materials.

Climate activists, who have tended to target the energy industry, are now turning their attention to big energy-consuming industries, especially mining, which is responsible for some 4 to 7 per cent of global greenhouse gas emissions, according one estimate.

Second, activists are increasingly turning the spotlight on various industries’ consumption of minerals. 

The environmental impacts of mining the metals used in digital and other devices have become a hot campaign topic targeting technology groups. 

More broadly, amid rising concerns that the world is locked into a treadmill of capitalist “overconsumption”, the miners, with their apparent focus on never-ending resource extraction, are seen to be feeding the beast.

The third challenge facing the mining sector is broader societal anxieties where concerns about the state of society, fuelled by the pandemic, have rarely been as intense.

Whether it be inequality, damaging the environment, violating minority or labour rights, powerful companies are now called out when they are seen to do wrong, none more than big mining groups. 

Their operations are often vast, located in remote, deprived and environmentally sensitive regions, and often populated by minority groups.

The chief executive of Rio Tinto left his job late last year after the company destroyed a 46,000-year-old sacred Aboriginal shelter in Western Australia to make way for the expansion of a mine. 

Now mining executives around the world are treading ever more carefully, knowing that the potential of any transgression to explode in their faces is all the greater given the sensitive underlying social context. 

None of this is necessarily to support the substance behind all this anti-mining activism. Some campaigns are based on clear evidence. 

Others are loose with the truth and ideologically driven.

But even more than previous waves of social activism, the trend has the potential to reshape miners’ business models, posing opportunities as well as risks. 

In the past, the impact of activism was fairly limited: campaigns might create some bad headlines for companies and stir up local opposition, but little more.

Now, activists have greater power to affect commercial outcomes for miners because of two recent shifts: the proliferating commitments of big investors, themselves often sensitive to campaigns by activists, only to back companies with good ESG performance; and the growing sensitivities of industrial buyers of metals, such as technology and car companies, to reputational damage caused by their suppliers coming under fire.

Already, some miners are beginning to tweak their business models. 

Some, for example, are looking at ways to reshape their portfolios, seeking to buy assets with lower direct greenhouse gas emissions or water use. 

Others are beginning to work with their customers to create joint schemes to certify their minerals as “responsibly mined”, or to help them recycle the metals they use.

The common thread is ESG as a route to building stronger relationships with customers and investors rather than just a way to reduce criticism. 

It is an evolution in thinking for the industry that still has a long way to go — but is likely to continue to build for as long as those activists keep hurling the abuse.

Daniel Litvin is the founder and managing partner of Critical Resource, which advises companies on sustainability and geopolitical risk, and author of ‘Empires of Profit: Commerce, Conquest, and Corporate Responsibility.’

An Evening With Bach

Thoughts in and around geopolitics.

By: George Friedman

A friend of ours, Shem Guibbory, who is a violinist with the MET Orchestra in New York, came to our house last week for dinner. 

He agreed to play Bach’s Chaconne for an audience of us and a few other friends. 

I do not have an ear for music, but I kept thinking that this is how God sounded during the creation of the world. 

The music had a perfect order that could be seen only by gazing deeply into what appeared at first to be disorder. 

It struck me as extraordinary that a human being was able to capture God’s spirit on a piece of wood.

My business is the relation of order to disorder. 

Nations appear to be disorderly things, but for me there is deep order inherent to them. 

When one nation encounters another, the sound it makes is the cacophony of conflict. 

Yet in it is an order of necessity, which is the truth underlying the noise. 

Necessity, the constraints that compel a nation forward, seems chaotic, but from the chaos we can comprehend and even predict the direction of nations.

That I would claim any right to a piece of Bach’s transcendent music or my friend's superb delivery is of course the hubris you all put up with. 

But my goal here is not to discuss the divine tedium of being human but to consider how that tedium and Bach’s brilliance must give us a sense of God.

God is not a subject ever lightly taken, especially in our time, where suspicion of speaking of God is rampant. 

The Enlightenment was a celebration of nature, man and science. 

There was room for God as a courtesy. 

As the Enlightenment turned into modern science, the idea of an infinite God, the cause of all things, ceased to be the common cultural belief, overwhelmed as it was by the idea that all things human and universal were the product of matter. 

Science never denied the orderliness of nature but could not concede that what some call intelligent creation and others think of as God’s handiwork might be the origin of the order of the universe, of the political world or of human life. 

Science based on causation and the mere existence of order does not make the case for a force responsible for that order. 

For science, but not necessarily the scientist, the origin of the order cannot be known.

But when I listened to Bach, I encountered an order surreal in its complexity, seductive if I stopped trying to dissect it and simply capitulated to it. 

At that point I found beauty. 

Beauty is a concept that is difficult to grasp. 

It is said to be a matter of taste and therefore the creature of taste and nothing more 

But when I listened to Bach and watched the violinist draw the sounds through his bow, I realized both that this is beauty, and that if the beholder does not recognize this, then he is in some sense crippled. 

Beauty is not in the eye of the beholder but in the eye of the universe.

And when speaking of beauty, it is necessary to discuss a subject that is not appropriate to speak of in polite company: death. 

There are those who believe that physical death does not end life. 

There are those who argue that death annihilates life and consciousness. 

The former believe this to be a matter of faith, the latter a matter of science. 

For me, faith is something anyone can claim and build on it any edifice he desires. 

Who knows what’s true? 

But it is the materialistic definition of the world, and of death, that I find most troubling, and the trouble is embedded in Bach. 

How could a human being conceive of such sounds and construct the music? 

How can I pretend to understand the working of nations? 

How can the mind of any human being be filled with the extraordinary things it is filled with? 

Each of us in an hour encounters in his mind things he has seen, will see, or cannot see because nothing else like it exists. 

Each of us in that hour feels love, anger, lust and depression. 

Our minds are filled with the prosaic and the uncanny, and we live within that space expecting it to be so.

The brain is said to be the origin of thought, and all thought originates therefore in our bodies. 

But I know that I, George Friedman, can choose to think of things at will. 

Some might say that the brain generated the thought. 

It might contain that thought in its folds and crannies, but the brain cannot generate the complexity of thoughts that I think, because I feel myself choosing to think them, and because I experience them. 

The brain might be the retainer of thought, but there is an "I" here, and I know that I have chosen this word to write and that word originated from me. 

I may be delusional, but I think not. 

I might be an automaton, but Bach could not simply have been a channel for brain tissue to express the chemicals it generates.

If there is an "I" independent of the brain, then I can understand how Bach could have willed his music into existence. 

He chose to do so out of love for the beautiful. 

If that is so, then Bach was greater than his body, and when the container of Bach’s genius is broken, is Bach destroyed or is he free? 

Obviously, I am playing with the idea that there are more things on heaven and earth than are dreamt of in your philosophies. 

I don’t pretend to understand the universe, and I find even myself puzzling. 

But the idea that the rich complexity of thought and emotion is a product of the brain strikes me as simplistic. 

A more elegant explanation is that there is a soul, good or evil as it chooses, that cannot be contained in the Enlightenment.

This strange wandering into metaphysics does not depart from politics. 

The soul of one might be chaotic. 

The souls of many have in them a certain logic, not because they are the mechanistic production of appetites and manufactured thoughts, but because, like the universe, there is an order beneath the chaos, and in looking for constraints, I need to look more deeply. 

Yes, there are constraints, but they constrain more than the body. 

They constrain the wildness of our minds, a wildness we share with each other. 

The freedom of the soul struggles against the limits of the body in everyone in orderly ways. 

There is order to a nation, and it seems to be that wild currents are only at the surface.

I may be completely wrong about the world, and maybe there is nothing more than my appetite driving me. 

But just as scientists insist on causation, I must explain Bach. 

How could he compose a song that elevates us into places that I thought did not exist. 

How can this exist in the world – and it does – as a matter of material causality rather than as a man choosing to see the uncanny?

I can’t get there from the Enlightenment, and I fear claiming I know more than I do. 

I am already far away from my yard. 

Yet listening to Bach forces me to rethink what I do, and the universe itself. 

I think Bach intended that to be the case.