Urban Affairs: Mortgage Finance and Climate Breakdown

Interrupted Rhythms and Uncertain Futures: Mortgage Finance and Climate Breakdown

Climate Change Impacts on US Housing Market

• Intensifying climate-related disasters are striking cities across the US, provoking concern for the stability of the US housing market and broader financial system.
• Research estimates that US residential properties exposed to worsened flood risk are overvalued by $121-237 billion.
• Climate change could cause a new mortgage default crisis.

The 30-Year Mortgage and Its Uncertain Future

• For 75 years, working households in the US have been encouraged to pursue homeownership as a means of achieving middle-class status and securing personal livelihoods.
• The 30-year mortgage has been a key innovation, but experts are now warning that it may soon become a thing of the past due to long- and medium-term climate risks.

Racial Exclusion and Financial Instability

• The project of homeownership has been racially exclusionary and frequently disappointed in practice.
• Strains were acutely exposed a decade ago in the Global Financial Crisis.
• The financial system was stabilized in a way that worsened risks for many households.

Climate Risks and Mortgage Finance

• Climate risks are increasingly being experienced and governed at multiple illustrative moments of US mortgage finance.
• The paper takes a multi-scalar view, exploring how climate risks are being tracked and governed at different moments, including:
  • Working households at the front line of urban climate impacts.
  • Mortgage professionals brokering loans to these households.
  • Government-sponsored enterprises (GSEs) negotiating incoming federal climate risk disclosure requirements.
  • Capital markets off-taking GSE risks through financial derivatives like credit risk transfers.

Gaps and Tensions in Climate Risk Governance

• Gaps and tensions exist between household risks and financial system-preserving responses.
• New dangers of "climate redlining" are emerging.
• The financial system may stabilise in a way that worsens risks for many households.

Following U.S. Mortgage Finance

• The paper follows U.S. mortgage finance through four illustrative moments of emerging climate risk impact and intervention.
• These moments are grounded in extensive fieldwork, interviews, and/or document analysis.

Climate Change and Housing Reform

• The paper offers new insights into longstanding concerns for urban studies scholars, particularly issues of displacement and housing reform.
• These concerns are increasingly inflected by consideration of climate change.### Climate Disclosure Regimes and Financial Markets
• Christophers (2017) argues that emerging climate disclosure regimes fail to discard neoliberal notions of market discipline and rationality, which have led to the progressive deregulation of financial markets since the 1970s.
• These regimes continue to equate disclosing climate risks with actually lowering them, and keep private financial actors and markets in the driver's seat of governance efforts.

The Financial "Following" Method

• The financial "following" method, used by scholars such as Aalbers (2009), Crump et al. (2008), and Wyly et al. (2009), exposes important distributional and justice concerns in the subprime crisis.
• This method explores the multi-scalar mortgage value chains and breakdowns that generated the subprime collapse.

Climate Change and Housing Markets

• Experts estimate that in the coming decades, approximately half a million homes in the United States will be on land that floods once a year.
• This may result in drastic changes in insurance premiums and coverage, as well as property values, with the state of Florida alone expected to see between $10 billion to $30 billion in property devaluations linked to climate change by 2030.

Mortgage Professionals and Climate Risk

• Mortgage professionals, including loan officers, mortgage underwriters, and risk modelers, play a key role in shaping what households know about climate-related risks before they are "locked in" via long-term mortgage contracts.
• Mortgage lenders are directly exposed to climate risks in both acute and chronic terms, and may transfer these risks to other market stakeholders.

Mortgage GSEs under Federal Climate Risk Disclosure

• The 2021 Executive Order on Climate-Related Financial Risk compelled a government-wide accounting of climate exposures, including for Mortgage GSEs like Fannie Mae and Freddie Mac.
• These institutions have crucially supported—and assumed much of the systemic risk of—the U.S. residential mortgage system, and will be affected by climate risk disclosure pushes.

Four Moments of Climate-Financial Risk in U.S. Housing

• Moment I: Frontline households, such as Françoise's, face daunting futures due to climate-related risks and rising insurance premiums.
• Moment II: Mortgage professionals, including lenders, brokers, and underwriters, are increasingly aware of climate-related risks, but may transfer these risks to other market stakeholders.
• Moment III: Mortgage GSEs under federal climate risk disclosure, with institutions like Fannie Mae and Freddie Mac, will be affected by climate risk disclosure pushes.
• Moment IV: (Not explicitly mentioned, but implied) The need for constructive ways to tie these disparate dynamics together without prompting substantial disruptions to housing provision or financial markets.### Climate Change and Mortgage Lending
• In May 2021, the Biden administration issued an executive order to assess climate-related financial risks to the federal government and the US financial system.
• The order may significantly affect US residential mortgage lending, particularly for government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac.

GSEs and Mortgage Securities

• GSEs purchase a significant share of mortgages made by private lenders and securitize them, aggregating pools of individual mortgages with a common risk profile and selling them to capital markets.
• This practice allows mortgage lenders to recycle their capital into new loans and transfers much of the risk to GSEs and other investors.
• In the 2000s, private investment banks took up this established GSE practice, using it to channel more capital into high-risk, high-return predatory home lending, creating a boom in "private-label" mortgage-backed securities (MBSs).

Climate Risk and Mortgage Lending

• Climate change poses significant risks to the mortgage system, and regulators are taking steps to address this risk.
• The Federal Reserve has launched a pilot climate scenario analysis to evaluate the aggregate credit risk relating to residential and commercial real estate.
• The Office of the Comptroller of the Currency (OCC) has published draft principles for managing climate-related financial risks across banking activities, including mortgage lending.
• These moves will increase the regulatory burden on mortgage lending, and may lead to changes in lending practices, such as incorporating climate risk into underwriting and risk management.

Credit Risk Transfer (CRT)

• CRT is a financial derivative product that allows GSEs to sell credit risk to investors, aiming to reduce their own exposure to mortgage defaults.
• CRTs are used to transfer credit risk from GSEs to private market investors, which can help to reduce systemic financial risk.
• Advocates argue that CRTs can help to mitigate climate risk by spreading risk to a more geographically and institutionally diverse network of investors.

Criticisms of CRT

• Critics argue that CRTs may not be effective in managing climate risk, and may even exacerbate existing inequalities and injustices.
• CRTs may create an additional ethical concern, as they allow speculative financial investors to bet on—and against—communities and cities' futures under climate change.

Conclusion

• The management of climate risk in mortgage lending raises crucial questions about justice, equity, and the prioritization of interests.
• As new frontiers of financial practice emerge in relation to climate risk, it is essential to examine whose interests are being privileged and what underlying housing risks are being managed.