The root causes of natural disasters By Scott Sumner

When an area is hit by a natural disaster, the media tends to focus on the proximate cause—a storm, earthquake or some other unusual event. But in many cases there are also deeper causes, which offer a more powerful explanation. Thus the proximate cause of a North Korean famine might be a drought, whereas the deeper cause is bad economic policies. The proximate cause of the high death toll in an Italian earthquake is the collapse of buildings, whereas the deeper cause might be something like corruption in the building industry. For the recent financial crisis, the proximate cause was a lot of loan defaults, whereas the deeper cause was moral hazard created by FDIC, Too-Big-To-Fail, and the GSEs.

The Houston area is currently suffering from a very costly disaster:

Flood damage in Texas from Hurricane Harvey may equal that from 2005’s Hurricane Katrina, the costliest natural disaster in U.S. history, said an insurance research group on Sunday. . . . Hurricane Katrina resulted in more than $15 billion in flood insurance losses in Louisiana and Mississippi that were paid by the National Flood Insurance Program (NFIP), a federal program that is the only source of flood insurance for most Americans. But Andrew Siffert, the resident Meteorologist at insurance broker BMS Group said it was easy to understand that Harvey will easily reach well over $10 billion in economic loss, and estimated the insured loss at over $5 billion. That figure did not include money that would be paid by NFIP, he added. The NFIP is already deeply in debt and likely will have to be bailed out again by U.S. taxpayers, as it was after Katrina, to cover the bill for flood damage claims from Harvey.

Just like FDIC, the NFIP program creates excessive risk taking. It also leads to the development of fragile coastal areas, which is why it is opposed by an unusual coalition of free market advocates and environmentalists:

The NFIP was created in 1968 after private insurers stopped selling flood coverage. Critics have said the program provides a misguided tax subsidy to coastal and river valley property owners, encouraging development in flood-prone, often environmentally sensitive areas such as wetlands. Congressional reform efforts, supported by a coalition of environmental activists and free-market advocates, have largely been thwarted by waterfront real estate interests.

In this particular case, I doubt whether the NFIP played a major role in the disaster, as much of the damage has occurred far from the ocean. But in the case of other coastal storms, the role of flood insurance is much more important, as it encourages the construction of vacation homes on outer islands that are easily overrun by hurricane level storms.

There’s another more subtle problem with the Federal government providing disaster relief. This takes pressure off of states and local governments to take preventive actions. If Louisiana had known that it would have had to foot the entire $15 billion tab for Hurricane Katrina, then they might have done more preventive work such as improving the levies along the river.

In the case of Houston, it’s too late to fix the federal insurance policy. Going forward, a good first step might be to turn the insurance function over to the states, perhaps accompanied by some sort of block grant. States would then have the incentive to explore options that would minimize the risk of catastrophic insurance losses.

PS. Good luck to everyone on the Texas coast–I have some relatives down there.