Now that the human catastrophe is hidden away in temporary morgues, hotel rooms and relatives' homes, the banking sector is counting up the financial reckoning of Katrina. The numbers are going to be big. I'll cover the major hits here, but other indirect effects will emerge as pressure builds in the system.
Challenging all predictions on the economic scale of Katrina is the fact that the US economy is over indebted at all levels: individuals, businesses, cities, counties, states and federal government. As a result, there are no excess reserves or savings anywhere to finance rebuilding or help others out of the crisis.
The main implications are:
* Mortgage Defaults
* Insurance Recoveries
* Bankruptcies
* State and municipal bond defaults
Mortgage Defaults
Mortgage defaults
are expected to soar as a result of Katrina. 400,000 may have lost their jobs and over 800,000 have lost or damaged homes, but the mortgage must be paid all the same. Although most banks in the region have provided a temporary respite in payments, the respite is only expected to last for three months maximum.
The banks fear defaults as much as the borrowers, as in many cases the properties securing the defaults will be worth far less than the value of the mortgage. 160,000 homes were destroyed by Katrina, and about 400,000 others were damaged. We all know that Americans have borrowed extensively against their homes to finance consumption in recent years, meaning that mortgages in many affected areas will be worth more than what's left of the house. The banks may well be reluctant to foreclose and therefore willing to negotiate with borrowers in trouble.
The difficulty with banks relaxing their enforcement, however, is that the debt just escalates further. As a result, the worst of the mortgage defaults will probably peak one or two years from now after people have given up all hope of regaining financial stability.
Insurance Recoveries
Estimates of insured losses are now ranging between $25 and $60 billion, making Katrina one of the most significant loss events in insurance industry history. 10 insurance companies are on watch for ratings downgrades and several Lloyds of London syndicates may be at risk.
For individuals who are most concerned about property insurance, Katrina's storm damage and damage due to flooding from storm surge and levee breaches are being treated as separate events by the insurers. This is important because although most policies for homeowners protect against hurricane damage, they generally exclude flood damage. Only 25 to 40 percent of homes in the affected region had flood insurance.
Politicians are generally staying well clear of the issue, but those who are intervening are increasingly coming in on the side of the insurers. If insurers were forced to pay for damages beyond the scope of policies, they would abandon insuring the region altogether rather than face future claims and losses.
Bankruptcy
Borrowers may well be in a position where they have to pay both the cost of a new home and also the mortgage on a damaged or destroyed home. In addition, many have put the costs of evacuating and living in temporary housing on credit cards. The rapid escalation of debt at a time when many are facing uncertainty about jobs and future living arrangements puts Katrina's evacuees at huge risk of finding themselves in a financial mess too great to recover from without bankruptcy. Inevitably, unless they have family or other resource to fall back on, many will become bankrupt.
Although Democrats in Congress have sought relief for Katrina victims forced into bankruptcy, the Republicans who fought so hard to secure protection for credit card companies are determined to preserve the harshness of the new regime coming into force in October. Bankruptcies caused by natural disasters tend to peak only one or two years later, so it seems that even if temporary respite were given, most of Katrina's victims would fall under the stricter statute anyway.
State and Local Bond Defaults
The Gulf region has been decimated economically, and the state and local governments are facing a huge economic crisis that could undermine the $14 billion dollars of debt already held by municipal bond holders. The states, counties and cities stand to lose the revenues to pay those debts, possibly precipitating defaults. Without property taxes, sales taxes, income taxes, corporate taxes, gambling taxes and hotel taxes, it is unlikely that states and municipalities will be able to recover fast enough to make payments as due on their vast outstanding debts.
While Congress is reluctant to "bail out" bankrupt evacuees of the storm, they are acting quickly to protect the bond markets. State governments have already rushed to Washington with a list of tax credits and other incentives they want to help retain businesses in the region and schemes such as the Liberty Bonds issued by New York City after 9/11 to aid states and municipalities in refinancing their debts.
Defaults in the municipal bond markets are rare, but an event of this scale is unprecedented in disrupting the finances of states, counties, cities, individuals and businesses all at the same time. It may be several months before the implications for local governments are fully assessed, and even a year or so before the effects on the tax base are fully recognised.
Municipal bonds are all guaranteed against default, but the market for this specialist insurance is highly concentrated in 8 firms, with 4 firms having significant risk exposures to Katrina-related defaults.