On the Economics of Natural and other Disasters

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A business in Port Aransas posts a sign looking for a framer in the aftermath of Hurricane Harvey.

Scott Ball / Rivard Report

A business in Port Aransas posts a sign looking for a framer in the aftermath of Hurricane Harvey.

Natural disasters like earthquakes, hurricanes, and tsunamis have a surprisingly limited impact on overall economic growth, positive or negative.

It depends on many factors, such as where the economy and confidence are at the time of the disaster, as well as on the perceived strength, conviction, and competence of authorities’ responses.

In general, when a city like Houston – which has a GDP higher than most U.S. cities – is hit, there is a massive, but temporary negative disruption of production and distribution activities – supply chains in particular feel those immediate effects. Offsetting that is the positive impact of rebuilding efforts. That’s why the net effects tend to be zero in the long run, and that is a good default assumption to make regarding the economic impacts of disasters like Hurricane Harvey, 2012’s Hurricane Sandy in New Jersey, the 2011 Japanese Tsunami, or even events like 9/11.

Conceptually, there are four possible economic scenarios or outcomes to a big shock or natural disaster.

The first is that the economy never fully recovers. This can be true in less developed countries where current political and legal institutions have deteriorated from what they were when the economy’s infrastructure – roads, hospitals, etc. – was built. That means that much of the damage created by natural catastrophes becomes permanent rather than transient.

The second case occurs where the economy’s institutions remain more or less the same after a disaster. This has been the case in much of the developed world, namely the United States, Europe, and Japan. Damaged areas in these economies tend to get rebuilt fairly quickly, so the impacts are usually transient rather than permanent.

In the third case – the reversal of the first scenario – the economy or damaged area comes back stronger than it was before. This is believed to be possible when political and legal institutions have improved in the years since the region’s infrastructure was built.

The final case is that of “leap-frogging” innovation, where the long-term result of a disaster is a vastly improved and rebuilt economy. Japan and Western Germany after World War II are often cited as examples of this fourth scenario.

But what about the municipal bonds issued by the affected municipalities? That’s an intriguing question for investors. Believe it or not, only one municipal bond default occurred following Hurricane Katrina in 2005, the costliest and most destructive storm in U.S. history, according to the National Oceanic and Atmospheric Administration.

With Hurricane Harvey, public infrastructure, hospitals, public housing, water and sewer systems, and electric utilities will likely see significant amounts of damage and disruption in affected areas throughout Texas. Municipal bond debt service payments may be vulnerable to disruptions in areas that were hit hardest. But given expected federal and state relief that is likely to be provided to local bond issuers, I believe there is little chance of widespread bond defaults. The immediate impact to municipal bonds in the affected regions will likely be a reduction in “credit cushion,” or credit protection, so bonds’ credit ratings might be under some pressure in the near future as bond issuers are financially reassessed. In the near-term, these bond prices may be impacted negatively as market participants attempt to reprice credit risk of impacted bond issuers, but there is little reason to expect long-term impacts based on historical precedents.

In fact, a recent Barron’s article cited several credit analysts describing trade in Houston municipal bonds as pretty normal, and Bloomberg pointed out that a similar, muted reaction followed Hurricanes Katrina and Sandy. That’s because, “as devastating as the losses are, local governments will receive federal relief funds, state support, and insurance claims to allow them to recover. Texas enjoys a top-notch triple-A credit rating, which means it has the reserves to fund operations and make debt payments until additional funds become available or revenues return,” according to Barron’s.

But overall it is still too early to say. For example, the impact on municipal utility districts, which issue property tax-backed bonds to finance infrastructure for new housing developments, depends upon how many people permanently abandon their houses or neighborhoods and never return. We won’t know that for quite a while. As far as downgrades go, where credit rating agencies lower the credit ratings of existing bonds – which puts downward pressure on their price – most of these, if they to occur, would probably be temporary and confined to lower rating categories.

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