Are Mortgage-Backed Securities Storm Proof?

David Burt, founder of DeltaTerra Capital, believes that climate risk is underpriced in residential mortgage-backed securities (RMBS) with exposure to climate change hot spots.

“The market’s failure to integrate climate science with investment analysis has created a mispricing phenomenon that is possibly larger than the mortgage credit bubble of the mid-2000s,” Burt wrote in a presentation to prospective clients, Insurance Journal reports.

According to Burt and other investors, hurricanes, flooding and other disasters pose a far larger threat than is currently being priced into mortgage securities. A key culprit may be outdated flood maps, meaning far fewer people are required to have flood insurance than are at risk, the investors and researchers say.

“The bet I’m making is that many regional markets will experience large price declines in response to increasing costs related to the geography-specific risks,” Burt said.

At a recent hearing hosted by the Financial Services Subcommittee on National Security, International Development and Monetary Policy, environmental experts discussed the risks to the National Flood Insurance Program (NFIP) posed by climate change, saying the situation is likely to worsen in the coming years.

“Flood insurance is top of perils we have to face,” said Andy Karsner, who served as U.S. Secretary for Energy Efficiency and Renewable Energy during the George W. Bush administration, The Hill reports. “It is imperative for [insurance companies] to develop new tools of risk management because they are operating on very old model inputs and ancient legacy flood maps.”

Marshall Burke, assistant professor of earth system science at Stanford University, said at Wednesday’s hearing that the evidence from climate change research suggests southern states are most vulnerable to flooding.

“On the coast, what we know about tropical cyclones or hurricanes — we don’t have clear evidence that there will be more or less of them — but we know they will be more powerful and move more slowly. That will dramatically increase the likelihood of coastal flooding,” Burke said.