In a previous post, I wrote about Harvey and I have also done a radio interview about the local economics of disasters. The key point to keep in mind here is the importance of protecting life in the face of a severe disaster. The death rate (deaths per million people exposed) is really low and this is wonderful and basic economics predicts this.
Look at the cover from today's NY Post. $160 billion looks like a very big number. This is the current estimate of the total cost caused by this disaster.
But the number doesn't look so big when you remember that the US economy's GNP is 19 trillion dollars per year.
Let's think this through. Suppose that all of the $160 billion damage bill is due to destroyed homes. To keep this simple, suppose that every house in the affected Hurricane Harvey area was worth $200,000 the day before the disaster. If $160 billion dollars of damage occurred, then 1.6 billion/200000 = 800000 homes were destroyed.
If the home is worth $200,000 then a good prediction of its annual rental flow is .05*200000 = $10,000. This is annual rental flow of income that the owners of the homes have lost because of the disaster.
UPDATE, I have corrected my algebra mistake and rewritten this.
So, under my assumptions and I have made up some assumptions above to make this more stark. In an economy where GNP is $19 trillion each year; 800,000 asset owners have lost an annual flow of $10,000 for 70 years (the lifetime of a durable home).
NOW , note that I have assumed that each of these owners has a 0 mortgage. If such individuals had a 75% LTV then they can default on their mortgage and walk away with a $50,000 loss in equity or an annual loss of $2,500. In this case, the shareholders of the banks who made these loans will bear the incidence of the shock.
Is this a shock to our macro economy? It could be if this sets off a ripple effect through the banking sector. But, I don't think this will happen. Instead, this is an awful regional income effect. The worst disaster in U.S history in terms of sheer water (11 trillion gallons) barely affects the national macroeconomy because the United States consists of over 300 major cities. We are a spatially diversified portfolio of cities. I am concerned that a decline in Houston prices could trigger a local mortgage default cycle (strategic default) and this could have broader consequences. So, the distribution of LTV across home owners and the impact of the shock on home prices will play a key role in determining short term increases in mortgage default risk.
Of course, given our current government programs --- the costs of cleaning this mess up will borne by the nation's tax payers through our safety net programs and our current spatial subsidies to affected regions. But, there are 340 million people in this country. If the unaffected 320 million people each paid an equal share of the $160 billion in damages, then each of us would face a one time fee of $500 each or an annual fee of $25 (assuming a 5% interest rate).
Let me be clear, those who have suffered at ground zero have suffered greatly. The question moving forward is how to rebuild Houston and who bears the incidence of this. I believe that the Houston property owners should pay for their own defense since they gain directly through capitalization effects (i.e higher home prices) for such a defense.