If you thought the governmental failure to regulate CDOs resulted in a worldwide real estate crash that could have been avoided with proper regulation, you are NOT going to be pleased to know that the new real estate crisis will occur on October 1, 2013.
This is a prime example of why voters are sick and tired of Washington ineptness. The new real estate crisis will cause coastal real estate owners to default on loans by the hundreds of thousands - because of FEMA. The October 2013 Real Estate Crash may be slowed down by Congress' delaying the implementation of the Biggert Waters Act[i] of July 2013, revising the National Flood Insurance Program ("NFIP"), but Congress will need to act quickly. National attention was focused on the problem with FEMA's poor operation and under-funding of the NFIP when Super Storm Sandy hit New York City and New Jersey. Since then, FEMA (NFIP) has been borrowing from the general budget to cover the cost of payments of flood insurance claims because the NFIP program has not been self sustaining through maintenance of surplus funds in prior years when claims were less than revenues, instead the excesses were remitted to Congress to use in the general budget.
Sandy's waters have retreated, but the problem caused by the Biggert-Waters Act of July 2013 is that the intentions of maintaining the flood insurance program included many ancillary consequences now spinning out of control because of the ineptitude of FEMA. For instance, the new NFIP law calls for the remapping of flood zones, which has not occurred as required under the act and cannot occur as required because of unavailable resources and time to accomplish this. The new NFIP law calls for an end to subsidized rates for property owners whose property is identified by FEMA as flood prone. For example, after Sandy, FEMA released new "preliminary" flood insurance maps for New York City, replacing "advisory" maps sent by FEMA immediately after Sandy. Using theoretical data, which is admittedly wrong in many instances[ii], FEMA now shows a significant increase in the number of homes and businesses subject to flooding. Remember, the NFIP program is a national program with more exposures in California than any other state, however, considering New York City alone, the new maps double the number of city real estate structures in flood zones to more than 67,000 over the last map update in 2007, which was based on 1983 data.
Some may think that investors building in flood prone areas should simply know better. But the NFIP federal flood program facilitated lending and building in these areas for years. Federally insured loans require flood insurance guaranteed by the federal government. And the insurance is completely at the risk of the federal government, because as a practical matter, all approved claims are paid by FEMA/NFIP, so private insurance companies do not incur any risks of loss by participating in the FEMA/NFIP Write Your Own private insurance company program.
But come October 1, 2013, the risk of loss must be actuarially adjusted to reflect the "real risk of loss," assuming that FEMA could determine that and it could map it.[iii] The truth of the matter, however, is that neither the "preliminary or advisory" maps include the data from Sandy. And this is common throughout the United States, according to the FEMA Mitigation Branch Director Bill McDonnell. According to the official GAO Report to Congress (GAO 13-607), FEMA does not know the cost of the subsidies to the at-risk zones or the information to establish full-risk rates that should be charged to make NFIP actuarially sound.[iv]
The FEMA maps split severe risk areas into "V-Zones," or "velocity zones," and "A-Zones." V-Zones risks include waves higher than three feet above base flood elevation, while in A-Zones detailed hydraulic analyses have not been performed, so no base flood elevations or flood depths are shown. Therefore, both V-Zones and A-Zones have high rates, albeit A-Zones rates are a bit lower. Since Sandy, under the recently released FEMA maps, the extent of property subject to designation as V- and A-Zones has significantly increased in New York City.
The Extension Disaster Education Network says that under the October 1, 2013 rules, a typical property built in a flood zone at four feet below the expected flood level (established most recently based on "theoretical data") now requires one with a prior flood premium of $1,410 per year to suffer increases over five years to $9,500 per year.
These changes will be felt well beyond New York and New Jersey buildings hit by Sandy. For instance, Michael Hecht, president and chief executive of the Greater New Orleans Inc. Regional Economic Alliance (GNO, Inc.), estimates that the premium on a $350,000 primary residence in a Louisiana A-Zone that had never flooded will rise from $633 per year to $28,000 per year. For a full exposition of the impact of Biggert Waters from the perspective of Louisiana GNO, Inc., see the following: http://gnoinc.org/uploads/NFIP_Presentation.pdf and www.gnoinc.org/floodinsurance.
These examples of radical increases in premiums will occur all over the country, although the NFIP program has not been declared by FEMA or GAO to be financially insolvent. Quite to the contrary, GAO reports to Congress that the calculations of premiums versus claims for at risk properties is not available information; and yet, the data reported shows no real loss in the program collection of premiums versus claims. Instead, the premiums for 1987 through 2011 for subsidized policies have been $26.2 billion, while claims were $24.1 billion.[v] Comparing full-risk premium rates for NFIP, FEMA collected $33.7 billion in premiums and paid claims of $28.5 billion.[vi]
Ironically, according to ProPublica and WNYC, the SBA federal loan program has approved $766 million in disaster loans to 10,500 homes and businesses that the federal government admits will likely flood again, when reviewing the new FEMA maps of New York, and this excludes areas like Long Island and Connecticut. See the full article here. Similarly, in Florida, the premium increases are substantial, as reported most recently in the Tampa Bay Times on August 20, 2013.[vii] 270,000 properties face rate hikes characterized as "huge," with estimates reported, such as: "Jeff Grady, president and CEO of the Florida Association of Insurance Agents, has heard anecdotes of $3,000 premiums that will jump to $12,000 for policies renewed after October; or $9,000 premiums soaring to $22,000."... "That makes the business owners or property owners just gasp," Grady said. "Not only can't they afford it, it really devalues the property."[viii]
Chris Heidrick, owner of Heidrick and Co. Insurance in Sanibel Island's Lee County, is concerned spiraling rates will both dampen real estate sales and hurt small business. "I'm concerned about ground-level offices and shopping centers and small businesses. The T-shirt shop near the beach," he said. "The impacts are so far-reaching. This is not just impacting the rich people who have second homes."[ix]
Clearly, this federal flood insurance problem is serious. If we thought the lack of regulation of insurance of CDOs was a problem in 2008, this issue of flood insurance is more of a problem for more people than just Wall Street, which incidentally was hit hard by Sandy and closed for weeks after the storm. The change in the law and regulations of flood insurance under the Biggert-Waters Act impacts heaviest investors in banks, REITS, and commercial real estate, although main street and homeowners stand to suffer huge potential losses when small businesses and hundreds of thousands of home loans in new flood zone designations (made without accurate data to support the designations) cannot be paid and therefore are placed in default.
New FEMA maps must be drawn using 3D data from sources like Google Earth. "Lidar" mapping is under way but far from finished, and more recent data on projected water levels from climate change are being incorporated. In short, the mapping is not completed upon which to base actuarial analysis, not to mention that the risk of flooding is not a well defined concept in light of bigger super storms like Sandy and Katrina.
The even bigger problem is that Congress has treated insurance as a sacred cow since 1945, when the federal government overruled the Supreme Court decision in United States v. South-Eastern Underwriters Association, 322 U.S. 533, 562 (1944), when Congress passed the McCarron - Ferguson Act (15 U.S.C. §§ 1011-1015) declaring that the sale of insurance is not interstate commerce and unless Congress legislated to the contrary, only states should regulate insurance. As we know from the recent national health insurance debate, each state may pass mandates for coverage in its state. Despite this scheme, we all know that in the case of national disasters, the federal government declares national emergencies and provides "aid" following the event, including providing assistance to the uninsured victims. Obviously, Congress realizes that national disasters must be addressed as national priorities and Congress is fooling itself to address flood insurance for such disasters on a national basis ONLY after a disaster.
Banks and mortgage lenders, not to mention Fannie Mae (OTCQB:FNMA) and other federally insured loan programs in all coastal communities stand to suffer from incorrect maps and unnecessary increases in flood insurance premiums requiring significant increases in loan payments and escrows. Banks in Florida with commercial retail banking exposure to failed real estate loans resulting from the inability of borrowers to pay required flood insurance premiums as a result of the most recent Biggert-Waters Act of 2013, are as follows: PNC Bank (NYSE:PNC), JP Morgan/Chase (NYSE:JPM), Citibank (NYSE:C), BB&T, Branch Banking & Trust (NYSE:BBT), Regions Bank (NYSE:RF), Fifth Third Bank (NASDAQ:FITB), Sun Trust Bank (NYSE:STI), Wells Fargo/Wachovia Bank (NYSE:WFC), Bank of America (NYSE:BAC). Exposure to loan defaults among commercial banks throughout the nation is higher than REITS because twenty five percent of mortgage backed securities (MBS) are owned by banks and credit unions, while only five percent of MBS are owned by REITS.[x] Commercial real estate investors are exposed to loan defaults resulting from the flood insurance premium increases undermining MBS pledged to all secured creditors.
We know the insurance issues relating to all national disasters will continue to be a problem, particularly considering that casualty insurance excludes (with varying degrees of success, depending on the state law) damages caused by flooding. To recognize the need for clear, well constructed maps identifying the risks, which are well defined and properly calculated as risks of loss does not require much thought. Similar issues that faced the nation as a whole in 1999 led to the Gramm-Leach-Bliley Financial Modernization Act, which set minimum standards that state insurance laws and regulations were required to meet certain standards or else face preemption by federal law. In 2006, the issues on lack of uniformity among states led to a proposed National Insurance Act of 2006. Clear recognition of states' inability to regulate the national insurance industry and the clear need for a broader pool of insured policy holders (in order to reduce the premiums created by certain otherwise uninsured risks) have resulted in congressional responses: the Patient Protection and Affordable Care Act (Pub. L 11-148), the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L 111-203).
Temporary fixes of Biggert-Waters are proposed by Rep. Bill Cassidy, R-La., to reinstate the federal flood insurance premium subsidies ended by Biggert-Waters. The idea faces an uncertain future in the Senate, where Louisiana Democrat Mary Landrieu proposed an amendment to the Farm Bill restoring the subsidies, but the amendment was not voted on. Chances are that unless Congress acts, there will be wholesale defaults on loans. Homeowners recently sent large baskets of keys to Senator David Vitter, R-La., advising that their home loans will become unaffordable because of the mistakes of FEMA in its failure or inability to prepare accurate maps or present accurate actuarial analysis of risks.
But let's be fair to Congress and FEMA. If the actuarial analysis and mapping were easy and the risks tolerable, private insurers would attempt actuarial analysis of flood risks and mapping for profit. Neither is possible and the attempt of Biggert-Waters without mapping and without accurate actuarial analysis is clearly wrong, so all seem to be calling for Congressional action to revoke Biggert-Waters and for the implementation of a national flood insurance approach that is reasonable and that can be sustained in home and business loans.
A sample of the approach needed has recently been introduced by Senator Landrieu, D-La., who has introduced a standalone bill called the Strengthen, Modernize and Reform the National Flood Insurance Program (SMART NFIP) Act that would delay flood insurance premium increases, continue subsidized rates for homes that are sold, and allow the rebuilding of community facilities in V-Zones if they are destroyed in disasters.
After all, if the CDO crisis presented bank and insurance company failures that were "too big to fail," shouldn't we consider this economic impact from loan failures in all coastal communities in the nation as "too big to unwittingly allow"? Aren't the banks providing the coastal real estate loans, and the federal loan guaranty programs insuring the loans and related economic consequences "too big to fail"? Shouldn't Congress prevent the bank failure if FEMA is the cause of the failure? After all, a reasonable subsidy of the NFIP is currently provided by the homeowners and business owners who pay flood insurance premiums to FEMA. Certainly, the current approach to affordable payments by coastal communities who built lives and businesses with the assistance of the federal NFIP program should not now be immediately undermined by the federal government's regulatory taking of property without a rational basis (at least accurate mapping) or any (not to mention "due") process of law via Biggert-Waters.
If Congress can't get its act together soon, the new real estate crisis will begin on October 1, 2013.
[i] Pub. L. No. 112-141, §100205 (NYSE:A)(1).
[ii] In the United States General Accounting Office(NYSE:GAO) Report to Congress (GAO 13-607), the GAO reports, as required by law that: "FEMA generally lacks information to establish full-risk rates that reflect flood risk for active policies that no longer qualify for subsidies as a result of the Biggert-Waters Act and also lacks a plan for proactively obtaining such information." (See GAO 13-607, p. 30.)
[iii] "FEMA does not have sufficient data to estimate the aggregate cost of subsidies." GAO 13-607 at p. 27.
[iv] "The cost of subsidized policies to NFIP can be measured in terms of forgone net premiums (the difference between subsidized and full-risk rates, adjusted for premium-related expenses). However, FEMA does not have the historical program data needed to make this calculation. Because of this constraint, estimating the historic cost of subsidies on NFIP is difficult. FEMA also does not have information on the flood risk of properties with previously subsidized rates, which is needed to establish full-risk rates for these properties going forward." GAO 13-607 at p. 27.
[v] "Moreover, because flooding is a highly variable event, with losses varying widely from year to year, even analysis of the decades of historical data available could lead to unreliable conclusions about actual flood risks. Based on our analysis of NFIP claims data, we calculated the amount of claims attributable to historically subsidized policies from 1978 through 2011 to have been $24.1 billion, of which $15.2 billion is attributable to remaining subsidized policies. NFIP had $28.5 billion in claims for policies charged at the full-risk premium rates in the same time period. Based on data provided by FEMA on all subsidized premiums, we calculated the amount of premiums collected for all historically subsidized policies from 1978 through 2011 to have been $26.2 billion, of which $15.7 billion is attributable to remaining subsidized policies. Comparatively, FEMA collected $33.7 billion in premiums for policies with full-risk premium rates for the same time period." GAO 13-607 at p. 30.
[vi] Ibid. See fn 5, supra.
[x] American Banker, Risk Management, June 1, 2013, REITS Raise Red Flags for FSOC. http://www.americanbanker.com/magazine/123_6/reits-raise-red-flags-for-fsoc-1059167-1.html.