Climate Change Threatens Fannie Mae and Freddie Mac: Is a Financial Crisis Looming?

As the impacts of climate change intensify, the financial stability of Fannie Mae and Freddie Mac—two government-sponsored enterprises that back half of the nation’s outstanding mortgages—is becoming increasingly precarious. With rising sea levels, escalating flood risks, and increasing wildfire occurrences, homes located in vulnerable areas are beginning to depreciate in value, posing a significant challenge not only to homeowners but also to the broader financial system. Fannie Mae and Freddie Mac play a crucial role in maintaining liquidity in the residential real estate market by purchasing mortgages from banks and repackaging them into securities. However, as the Biden administration’s financial regulators identified in their initial year, the mortgage market is one of the primary channels through which climate change could destabilize the financial system. Despite numerous reports and discussions surrounding this issue, the Federal Housing Finance Agency (FHFA), which oversees Fannie and Freddie, has yet to provide concrete guidance on mitigating climate-related risks. Concerns over potential increases in housing costs, especially for low-income households that disproportionately find themselves in high-risk areas, have significantly hindered progress. Housing advocates and former officials have expressed frustration over the vague responses from the FHFA. "It came out and I thought, where's the rest of it?" remarked Carlos Martín from the Harvard Joint Center for Housing Studies, highlighting the urgency for a more decisive strategy. The financial implications of climate change for Fannie and Freddie are severe. Reports indicate that homes in high-risk flood zones may be collectively overpriced by at least $187 billion. The Congressional Budget Office has warned that federally backed mortgages could face approximately $190 billion in flood damages over the next three decades. While banks are becoming more cautious about extending credit in flood-prone regions, Fannie and Freddie have not yet begun to formally account for these risks in their loan underwriting processes. Currently, the enterprises rely predominantly on traditional insurance models to manage climate risks, but as extreme weather events increasingly affect regions beyond designated flood zones, this reliance is becoming more precarious. The soaring insurance costs, driven by these disasters, can lead to financial delinquency for homeowners, regardless of whether their property is damaged. Susan Crawford, a senior fellow at the Carnegie Endowment for International Peace, pointed out that unforeseen large losses could jeopardize Fannie’s and Freddie’s profitability, threatening their ability to keep the mortgage market liquid. "This is all about the safety and soundness of the enterprises," she asserted, warning that the current approach is unsustainable as climate impacts worsen. Historically, Fannie and Freddie have operated under the assumption that their diverse mortgage portfolios would mitigate losses from regional disasters. However, the increasing frequency and severity of natural events could unravel this strategy. The possibility of recurrent flooding may lead to employer exodus from affected areas, shrinking tax bases, and, subsequently, diminished local governance capabilities. Pricing risks based on geography remains a contentious issue, with political pushback posing a significant barrier. Suggestions for implementing geographical pricing have met resistance, as many of the most vulnerable areas are inhabited by low-income and minority homeowners. The potential for exacerbating existing inequalities is a concern that weighs heavily on policymakers. Despite the challenges, some advocates suggest practical solutions to cushion the impact on at-risk homeowners. These could include adjusting fees based on borrower income levels or providing subsidies to facilitate relocations to safer areas. Additionally, incentivizing the purchase of homes with features designed to withstand climate impacts, such as elevated foundations or fireproof materials, could mitigate future risks. The Biden administration's focus on housing affordability has so far not led to a coordinated response to the emerging climate crisis. Simple actions, such as establishing energy efficiency standards for new homes backed by Fannie and Freddie, have also been sidelined, despite their potential to lower costs for homeowners while addressing climate change. As the political landscape shifts, particularly with the impending return of a more hostile administration towards climate change initiatives, the future of incorporating climate risk into federal mortgage underwriting remains uncertain. The past decade has shown that political concerns can overshadow necessary reforms, with significant implications for the stability of both the mortgage market and the housing landscape at large. In a world increasingly shaped by climate change, the question remains: Will Fannie Mae and Freddie Mac evolve to meet these challenges, or will they continue to move blindly forward, risking not just their own stability but that of the entire mortgage market? The financial viability of these enterprises—and the homes and families they support—hinges on the answers to these pressing questions.