Hurricane-ravaged homes represent a looming crisis for U.S. banks

With so many homeowners still days or weeks away from fully assessing their flooded homes, let alone returning to them, it is impossible to say with certainty how many billions of dollars in damage Hurricanes Harvey and Irma have caused in Texas, Louisiana, and Florida. The best estimates indicate a potential property loss of $200 billion or more.

One thing we know for sure: The vast majority of those flooded do not have flood insurance, and many will lack the funds to restore their homes and businesses to viability.

After each large storm, much attention is paid to the impact on the insurance industry. But the result of these catastrophic storms — and their increasing regularity — represents a looming crisis for America's banks. They have written mortgages on  millions of homes, some of which are sure to be abandoned by homeowners who simply cannot afford to repair them. In other instances, residents may move back into homes where significant water damage remains, and live with those conditions indefinitely because the storm has devastated their finances.

The banks, in these cases, can be left with homes that have no value other than the land they sit on — or severely diminished value at best. They have written, say, a $200,000 mortgage for a waterlogged home now worth not much more than half that, or less. When you multiply this out over the stunning devastation of Houston alone, where more than a quarter of the city was underwater, the result is massive risk and pending losses for banks. Bigger institutions will survive, but some smaller ones could already be in trouble.

Similar situations exist all around the country, and it is going to keep happening.

Houston has experienced major flooding in three consecutive years. Virtually all of Florida was in the crosshairs of Irma. Hurricane Sandy devastated the New Jersey coast just five years ago. As Hurricane Maria reminds us, the clock is ticking on every coastal city, big and small, up and down the East Coast and along the Gulf Coast. Inland communities are not exempt. Just ask the residents in and around Columbia, S.C., who were subjected a few years ago to a so-called 1,000-year-flood event. Less than 5 percent of the properties affected there were designated on the Federal Emergency Management Agency maps as "flood-prone."

Banks hold billions of dollars in mortgages in these areas, just a tiny fraction of which are protected by flood insurance. No easy solutions exist, but there are actions that can be taken to mitigate risk. First, Congress must reauthorize the National Flood Insurance Program, which over the last 40 years has amassed a $24 billion deficit. It cannot pay that back; the debt must be written off.

For the program to be sound, homeowners will have to pay much more realistic and expensive premiums. The consequence of that, however, is declining home values commensurate with significant increases in flood-insurance premiums.

Why? Because to pay, for example, a $20,000 annual premium on a home in a severely flood-prone area amounts to almost a second mortgage. Few homeowners want to pay that — and even fewer prospective buyers want to take that on.

The result is that a large number of coastal and inland flood-prone homes are not really worth what they appear to be, and that is a crisis for the banks that hold the mortgages. One significant study by the Florida Association of Counties concluded that for every $500 of flood-insurance premium increase, there would be a corollary reduction in property value of $10,000. In 10 years, flood-insurance premium increases alone would cause a decrease of up to $67 billion in Florida property values. That is a shocking statistic, especially if you consider that the problem extends beyond Florida and to flood-prone areas in almost every state in the nation.

Lenders must recognize that this is their problem and face it head-on, first by adjusting their flood-prone inventory and fully and realistically accounting for the risk.

The federal government, through FEMA, has compensated homeowners and businesses, even those without flood insurance, and these bailouts essentially also function as bank bailouts. What happens if they end?

Finally, forward-looking banks must get involved in providing financing for serious flood-mitigation efforts, both on the individual structure and on a communitywide basis. Lenders must begin to put conditions on future loans in flood-prone areas based on a realistic analysis of future risk inclusive of the effects of sea-level rise and to finance measures — as a business venture — to address these risks.

Up-front dollars spent in these ways are better expenditures than compensating for flood damage. And to the extent that they can forestall steep increases for flood-insurance premiums, the banks help protect the real estate economy and their own investments.

Banks are sitting on billions of dollars of risk, and if they do not address it, regulators will. Worse yet, plaintiffs' lawyers are already taking note — class-action suits against lenders are just around the corner.

Robert Sokolove, a Langhorne lawyer who specializes in flood-insurance matters, was FEMA's first associate general counsel for the National Flood Insurance Program. rdsokolove@aol.com