Gongloff: A $1 trillion time bomb is ticking in the housing market

Cassandras seldom get opportunities to be right about two disasters. Even the original Cassandra scored no notable victories after predicting the fall of Troy. But when a seer who successfully called one catastrophe warns of another coming, you might want to listen.

Years ahead of the financial crisis, David Burt saw trouble brewing in subprime mortgages and started betting on a crisis, winning himself a cameo in The Big Short by Michael Lewis in addition to lots of money. Now Burt runs DeltaTerra Capital, a research firm he founded to warn investors about the next housing crisis. This one will be caused by climate change.

In a webinar with journalists last month, Burt argued that U.S. homeowners’ wildfire and flood risks are underinsured by $28.7 billion a year. As a result, more than 17 million homes, representing nearly 19% of total U.S. home value, are at risk of suffering what could total $1.2 trillion in value destruction.

“This is not a ‘global financial crisis’ kind of event,” Burt said, noting the total housing market is worth about $45 trillion. “But in the communities where the impacts are happening, it will feel like the Great Recession.”

Burt’s estimate may actually be on the conservative side. The climate-risk research firm First Street Foundation last year estimated that 39 million U.S. homes — nearly half of all single-family homes in the country — are underinsured against natural disasters, including 6.8 million relying on state-backed insurers of last resort.

The issue is that in many parts of the U.S., insurance premiums don’t reflect the risk of climate-fueled catastrophes, which is growing as the planet warms. A record 28 weather disasters in the U.S. last year did $1 billion or more in damage, according to the National Oceanic and Atmospheric Administration. This year is on pace to at least match that record, with 15 such events so far — a tally that doesn’t yet include Hurricane Beryl, which might have caused $30 billion in damage.

Globally, the toll from natural disasters has topped $120 billion so far this year, the reinsurer Munich Re estimated this week. Only $62 billion of that was covered by insurance, a figure 70% higher than the long-term average. Most of this damage happened in the U.S., and much of it was borne by homeowners.

Insurers have been raising premiums in response to these catastrophes and to cover the rising costs of rebuilding and buying their own insurance through companies like Munich Re. Homeowners insurance premiums rose 11% on average in the U.S. in 2023, according to S&P Global Market Intelligence. They’ve risen by more than a third in just the past five years. In states on the front lines of climate change, including California, Florida and Texas, increases have been even higher.

But premiums still aren’t high enough, mainly because almost nobody wants them to be. Homeowners aren’t fans of paying exorbitant insurance rates, and they tend to punish politicians who let them rise too much. Higher premiums also hurt property values, threatening tax revenue. The result is market manipulation like California’s Proposition 103, which sharply limits how much insurers can raise premiums. And even if insurers could increase rates willy-nilly, they might think twice about chasing off customers — especially when laws and regulations are designed to discourage homeowners from suing insurers for uncovered damage.

“Every part of our financial and legal system at this point is devoted, singularly devoted, to keeping the status quo in place,” Harvard Law School professor Susan Crawford said in the webinar. “It will be difficult for us to adapt.”

First Street used a hypothetical California home to illustrate just how wildly divorced from reality insurance costs can get in some places. Say our imaginary Californians started out in 2010 paying an annual $2,000 home-insurance premium. If that increased by 7% a year — the absolute most the state will allow, and highly unlikely in any case — that premium would have hit $4,820 in 2023. Yikes! And yet that would still be $2,900 short of what the price should be to truly reflect how much Hypothetical Insurance Inc. has at risk, First Street estimated, considering climate change, inflation, reinsurance and other costs.

No wonder insurance companies have been fleeing California, Florida and other risky areas in bunches, leaving real-life homeowners stuck relying on state insurers of last resort. These policies are expensive and often inadequate. The providers are also at constant risk of insolvency. California’s FAIR plan faced $311 billion in potential losses at last count, and Florida’s Citizens Property Insurance Corp. faced a possible $525 billion hit. The federal National Flood Insurance Program, the biggest flood insurer in the U.S., is a consistent money-loser. Who would backstop these plans if they failed? Take a look in the mirror.

The logical solution is to price climate risk accurately, as the NFIP has started to try to do by finally ending its reliance on outdated flood maps. We’d no longer be subsidizing the building and rebuilding of homes in areas most vulnerable to chaotic weather. But the result of doing that all at once would be sudden, awkward price discovery in the housing market, with Burt’s $1.2 trillion of losses becoming reality.

We’ll have to find a happy medium, discouraging settlement along the front lines of climate change while also avoiding economic disaster. But as homeowners who have ended up in the path of a California wildfire or Florida flood can attest, sometimes the disaster comes when you’re not ready.

Mark Gongloff is a Bloomberg Opinion editor and columnist covering climate change. He previously worked for Fortune.com, the Huffington Post and the Wall Street Journal.