Everything's fine until it isn't: Lessons from NYC's fiscal crisis

Are we as blind to climate risks as NYC was to financial risk in the '70s?

Go see "Drop Dead City," a terrific documentary about the near-bankruptcy of New York City in 1974-75. What led to the city's fiscal collapse? The unexamined creation of a mountain of risk in which everyone involved—banks, local government, investors—found it convenient to believe that the next guy would handle things. Smart politicians knew there had been a longtime deferral of fiscal reality, but the money kept flowing. Until suddenly it didn't.

Willful blindness is the first chapter in this story. Canceled checks arrived from the banks and went directly into a closet. No one in NYC—until Harrison Goldin came along in 1973—reconciled them with the city's highly optimistic assessment of its financial condition. There were no real books; there was no accounting system. There was simply the belief that the city was so big and there was so much money flowing in and out that spending would be fine.

When reality became clear, New York faced a dire financial situation—$6 billion in the red—against a background of inflation and recession.

When it comes to the physical risks of climate change that are building in the US, the parallel to this first chapter is painful. Everyone knows that property insurance is rapidly repricing in response to climate risks as well as in response to climbing construction and reinsurance costs. But the details of this story are invisible: We don't know, ZIP code by ZIP code, how much people are paying for what kind of coverage, and how many non-renewal notices are going out.*

So even though rising insurance premiums and narrowing coverage are telling indications of financial risk—because without insurance you can't get a loan, and if you can't get a loan commerce stops—the amount and concentration of this risk is basically invisible to policymakers. It's like the NYC bank checks landing in a closet, unexamined.

Why don't we know? Because data collection is not yet routine or standardized across the individual state offices that oversee property insurance, and because public access to granular, ZIP-code level data is blocked based on the confidentiality concerns of insurers. Commissioner Jon Godfread of North Dakota, president of the National Association of Insurance Commissioners (NAIC), tells me this will change. "We're in the middle of developing a structure for that data call going forward, to make sure that not only will the regulators have the information [but also] so they can provide that to the policymakers."

Last year, the Federal Insurance Office within the Department of the Treasury tried to collect all this information. Several states, including Florida, Alabama, Louisiana, Georgia, Indiana, Montana, and North Dakota, refused to participate. Godfread explains that FIO's focus on climate risk made the data call a "political football in certain states." (The NAIC has called for the abolishment of the Federal Insurance Office.)

Godfread says his fellow commissioners want to be able to point out that although the climate is changing ("I mean, the math is the math, and the catastrophe risks are happening, and storms are becoming more intense"), there are other contributors to higher insurance premiums—including community failures to lower physical risk by requiring better building codes and zoning reforms, and higher housing replacement costs driven by inflation. And so NAIC will collect the data, on their terms, and they'll analyze it. Holistically, so that they aren't driven by someone else's climate risk focus. With any luck, they’ll also take into account where exposure is growing because people are moving into risky areas. (I wrote about this here.) "We've got to recognize the fact that if everything costs more, insurance is going to cost more," Godfread says.

NAIC's 2025 strategy refers carefully to "the growing risks posed by natural catastrophes" rather than climate risk.

From a policy perspective, all of this is both understandable and highly unfortunate. Yes, there are lots of costs going up—in fact, like NYC in the 1970s, we're facing an environment of inflation and recession—but the accelerating physical risks of climate change are acknowledged by everyone at this point (including the NAIC, even if they're not using the words).

What's not acknowledged, yet, are the interlinked fiscal risks signaled by these largely invisible rising insurance costs: inability to obtain credit (both for mortgages and infrastructure) as the banks eventually catch on, declining city and state revenues, city and eventually state inability to pay off debt as it becomes due, pleas to the federal government to fix local government insolvency, and, along the way, a great deal of disruption and dislocation of individuals. The parallel holds: These are the chapters of the New York City fiscal story following the one about canceled checks landing, unexamined, in the closet. It is easier to ignore these interconnected risks if data showing what's actually going on isn't visible.

Commissioner Godfread says, "The one thing [people] need to understand is that insurance doesn't fix risk. It's a teller of risk." He wants communities to address their physical risks, and says all insurance companies can do is signal risk through pricing. He has seen how hard it is to change building codes to require safer roofs in North Dakota because "the county commissions, the city commissions, the people who are on them are builders." (Emphasis mine.) And "There is such a disincentive, or such a resistance, to wanting to have those conversations [about modifying building codes] because that impacts the first dollar cost of a home," says Godfread.

Godfread wants us to remember that it was the banking sector that had trouble in the 2008 Great Financial Crisis. "The insurance industry weathered that storm fairly well," he notes.

It's a good point. How rigorous is the underwriting being done by banks in handing out mortgages and handling bonds when it comes to physical climate risk? Right now, banks are still collecting fees for making loans and shifting risk to Fannie Mae and Freddie Mac without looking very hard at physical climate problems.

Funny story: When the NYC reality—the $6 billion hole—suddenly became visible in 1975, the banks claimed that all the politicians had been fiscally irresponsible. "What tends to be forgotten," says someone who was there at the time, "is that for every bad borrower, there's usually a stupid lender." He goes on: "I'd say, 'You're absolutely right, but why the hell did you lend them money?'"

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*Federal flood insurance price data by county is available, but researchers still need to take a few steps to figure out how much that cost will climb over time.