Federal Flood Insurance Did Not Magnify Harvey and Irma
Back in 2008, and in the aftermath of the troubles within the financial sector, a popular theme emerged about banks “privatizing profits while socializing risk.” To believe their critics then and now, banks swing for the proverbial fences with an eye on big bonuses, but if their careless ways lead to insolvency, their errors are cushioned by taxpayer bailouts. It was and is a neat theory, but not a very realistic one.
Back to reality, banks have shareholders who would prefer to not see the value of their investments crash. Because they would, banks and other financial institutions conduct “stress tests” on a daily basis. That they do speaks to the superfluous nature of Federal Reserve-enforced tests meant to verify balance-sheet quality within the institutions they regulate. They’re superfluous given the basic truth that banks have shareholders, and shareholders would prefer to see the value of their investments go up. Excessive home run swings are logically bad for shareholders for them imperiling the odds of the future earnings that wholly inform the value of their investment.
And then it can’t be forgotten that in finance, much of the bonus pay comes in the form of restricted stock. Getting into specifics, employees of ‘08 flameouts Bear Stearns and Lehman Brothers were major shareholders (1/3rd and 1/4th respectively) of each. This isn’t to say that employee-owned companies never fail, but it is to say that investors and employee owners have a strong financial incentive to make sure that excessive, company-imperiling risks aren’t being taken. It doesn’t always work as ’08 attests, but the incentives are correct. When Bear and Lehman imploded, their employees felt it intimately.
After that, no reasonable CEO would ever take (or countenance) major risks based on the presumption of a bailout. Figure that Lehman wasn’t saved as is, and in Bear’s case the shareholders were largely wiped out as evidenced by the latter being sold to J.P. Morgan for $10 share. Its previous high was $133. While Bear Stearns was bailed out, its shareholders largely saw the value of their investment in the once high-flying investment bank vanish. Former CEO Jimmy Cayne held nearly 5% of Bear’s outstanding shares, but saw the value of them plummet. Worse were the reputational hits suffered by the top executives of both. Though once highly regarded and immensely rich, they saw their net worth decline in concert with a near total loss of reputation that high achievers logically hold dear.
All of the above is a long way of saying that no reasonable person, and certainly no individual skilled enough to reach the top of a major financial institution, would ever knowingly take firm-endangering risks based on the presumption of a federal bailout. These are prideful individuals we’re talking about, but also individuals with enormous amounts of wealth and reputation at stake. Dick Fuld (Lehman) used to be a major name on Wall Street, but now he isn’t. Same with Cayne. Though the mistaken bailouts that needlessly caused a financial earthquake in ’08 were logically bad for taxpayers, they were also horrid for their alleged beneficiaries.
Which brings us to the hurricane-related damage cruelly visited on Texas and Florida by Hurricanes Harvey and Irma. Americans have been typically compassionate and gracious, but have also been practical. Lots of houses were flooded, destroyed or both, so Americans have asked how to avoid a similar scenario in the future.
Many on the right have argued that the impact of the floods was magnified by flawed incentives. In particular, they contend that the National Flood Insurance Program (NFIP) has rendered Americans less careful about where they buy or build houses based on the assumption of a federal bailout should a flood wipe them out. As one op-ed put it, “The ravages in Houston and elsewhere would be far less if the federal government had not offered massively subsidized flood insurance in high-risk, environmentally perilous locales.”
Another op-ed contended that federal flood insurance is what props up ‘Acela Corridor’ (Boston-New York-Washington) types who typically have houses in Florida. So long as the privileged own houses in the Sunshine State, owners there will never be forced to “bear the cost of their life-style choices.” The implicit point in much of the commentary on the right is that federal flood insurance has rendered ownership of housing in flood-prone areas costless. The right overstate their case by a mile.
Up front, the right are correct that there should be no federal flood insurance. None at all. People should in no way be allowed to socialize losses that spring from flooded homes. Along these lines, flood insurance should reflect market reality through higher flood insurance premiums in high risk areas.
So while the right are correct that federal flood insurance should be abolished, they once again way overstate their case. For one, the NFIP caps compensation at $250,000. The latter isn’t nothing, but it’s nowhere close to what’s required to rebuild houses in frequently expensive coastal areas. As for Texas, it’s not reasonable to presume that fear of floods informed home-buying decisions as is. As was pointed out with great regularity during the worst days of Harvey, Houston and its suburbs were not historically viewed as being at risk of major flooding.
But the main thing is that federal backstops or none, no sane person would build where flooding is the accepted norm based on a subsidy. Not only is federal insurance capped way too low, but even if excessively generous no reasonable human would endure the agony that Texans and Floridians have over the past few weeks, all so that they can get in line for the federal dollars necessary to fix what is flooded, or totally destroyed.
Despite this, the right would have us believe that federal handouts were a major cause of Harvey and Irma damages. They can’t be serious. That they’re not serious isn’t to defend federal spending or subsidies for even a second. But just as no reasonable banker would risk his wealth and reputation based on the presumption of a bailout, so would no homeowner risk the disruption and total misery of power lost and home wrecked, all based on the presumption of capped federal compensation.
No doubt government breaks everything it touches, both foreign and domestic. No doubt we’d all be better off if the federal government were a fraction of its existing size based on strict adherence to the Constitution’s limiting principles. But when supporters of limited government suggest that federal subsidies cause people to buy and build where they risk having their wealth washed away, they’re just not serious. Instead, they discredit the very proper call for severely limited government.