The Bond Market Doesn’t Care About Climate Change
But there’s another element that helps cement the bargain: investors’ confidence that coastal towns will pay back the money they borrow. Homebuyers are irrational. Politicians are self-interested. But lenders—and the ratings agencies that help direct their investments—ought to have a more clinical view. Evaluating long-term risk is exactly their business model. If they thought environmental conditions threatened investments, they would sound the alarm—or just vote with their wallets. They’ve done it before—cities like New Orleans, Galveston, Texas, and Seaside Heights, New Jersey were all downgraded by rating agencies after damage from Hurricanes Katrina, Ike, and Sandy. But all have since rebounded. There does not appear to be a single jurisdiction in the United States that has suffered a credit downgrade related to sea level rise or storm risk. Yet.
To understand why, it helps to look at communities like Seaside Heights, the boardwalk enclave along the Jersey Shore whose marooned roller coaster provided the definitive image of the 2012 storm.
Seaside Heights has a AAA rating from Moody’s. Ocean County, New Jersey—the county in which Seaside Heights sits—has a AAA rating. In the summer of 2016, before Ocean County sold $31 million in 20-year bonds, neither Moody’s Investor Services nor S&P Global Ratings asked about how climate change might affect its finances, the county’s negotiator told Bloomberg this summer. “It didn’t come up, which says to me they’re not concerned about it.”
The credit rating agencies would deny that characterization—to a point. They do know about sea level rise. They just don’t think it matters yet. In 2015, analysts from Fitch concluded, “sea level rise has not played a material role” in assessing creditworthiness, despite “real threats.” Hurricane Sandy had no discernible effect on the median home prices in Monmouth, Ocean, and Atlantic Counties, which make up New Jersey’s Atlantic Coast. The effect on tourism spending was also negligible.
“People continue to want to be there and will rebuild properties, usually with significant help from federal and state governments, so we haven’t felt it affects the credit of the places we rate.”
There are three reasons for that. The first is that disasters tend to be good for credit, thanks to cash infusions from FEMA’s generous Disaster Relief Fund. ““The tax base of New Orleans now is about twice what it was prior to Katrina,” Laskey says, despite a population that remains 60,000 persons shy of its 2005 peak. “Longer term what tends to happen is there’s rebuilding, a tremendous influx of funds from the federal and state governments and private insurers.” Local Home Depots are busy. Rental apartments fill up with construction workers. Contractors have to schedule work months in advance.
Look at Homestead, Florida, Laskey advised, a sprawling city south of Miami that was nearly destroyed by Hurricane Andrew. Today it is bigger than ever. “If there was going to be a place that wasn’t going to come back, that would have been it.”
“We take a lot from history, and historically what’s happened is that these places are desirable to be in,” explains Amy Laskey, a managing director at Fitch Ratings. “People continue to want to be there and will rebuild properties, usually with significant help from federal and state governments, so we haven’t felt it affects the credit of the places we rate.”
What emerges from the destruction, for the most part, are communities full of properties that are more valuable than they were before, because they’re both newer and better prepared for the next storm. Or as a Moody’s report on environmental risk puts it, “generally disasters have been positive for state finances.” But this is entirely dependent on federal largesse: After Massachusetts brutal winter of 2015, FEMA granted only a quarter of the state’s request for aid. Moody’s determined that could negatively impact the credit ratings of local governments that had to shoulder the cost of snow and ice removal.
Second is that people still want to live on the shore. “The amenity value of the beach is something you can enjoy every day of the summer,” says Robert Muir-Wood, the chief research officer at Risk Management Solutions. “People may say, ‘The benefits of living on the beach to my health and wellbeing outweigh the impact of the flood.’” That calculus is strongly influenced by affordable flood insurance policies, but it has not changed. In a way, despite the risks, the sea is a more dependable economic engine for a community than, say, a factory that could shut its doors and move away any minute.
Most bonds get paid off from property taxes. If property values remain high, bondholders have little to worry about. If, on the other hand, property values fall, tax rates must rise. If buildings go into foreclosure, or neighborhoods undergo “buy-outs” to restore wetlands or dunes, more of the burden to pay off that new seawall falls on everyone else.
Third: Most jurisdictions are large. New Jersey’s coastal counties also contain thousands of inland homes whose risk exposure is much, much lower. Adam Stern, a co-head of research at Boston’s Breckinridge Capital Advisors, argues that the first credit problems will come for small communities devastated by major storms.
Still, Stern said, his firm looks at these issues. “One of the things we try to get at when we look at an issuer of bonds that’s on the coast: Do you take climate change seriously? Are you planning for that?” Still, he said, bond buyers—like everyone else—discount the value of future money, and hence future risk. When could the breaking point for the muni market come? Stern predicts that will happen when property values start to discernibly change in reaction to climate risk. It’s a game of chicken between infrastructure investors and homeowners.
“I think we’re in territory that’s changing right now,” says John Miller, an engineer studying climate change and credit risks at Wharton’s Risk Center. He pointed to Sea Bright, a barrier-island borough of New Jersey just south of New York Harbor. A municipal analysis concluded that by 2050, one in five of the borough’s parcels will be underwater—amounting to 17 percent of the total value of all Sea Bright real estate. Under 2050 SLR predictions, a 100-year flood would put 99 percent of parcels underwater. That year, 2050, is just beyond the 30-year frame used to sell both homes and bonds.
Generally, though, if you are looking for financial markets to start enforcing the risks of climate change, don’t look at towns on the rebound. Those places—whether they’re building seawalls or simply enforcing building codes on reconstructed properties—are better prepared. “The places you’re going to see the biggest disasters,” Muir-Wood predicts, “are the ones that haven’t been hit.”