Volume 12, Number 5                                          December 12, 2008

The Farmer


Hurricane Katrina and the financial fall of America

By Dr. Ridgely Abdul Mu’min

The black victims of Hurricane Katrina have continued to be victimized by the US government, now in the form of discrimination in the implementation of Louisiana’s $11 billion federally funded recovery program called the "Road Home". On November 12, 2008 fair housing and civil rights groups filed a lawsuit against HUD and the Louisiana Recovery Authority on behalf of 20,000 African-American homeowners, claiming that Blacks are facing huge gaps between the amount of their Road Home grant awards versus the cost to rebuild their homes when compared to their White counterparts.

As much as Katrina has hurt the black population of New Orleans, Katrina’s real devastation may have to be measured in terms of her overall impact on the American economy in light of the current financial meltdown. On May 3, 2004 the Honorable Minister Louis Farrakhan warned the Bush administration to pull the troops out of Iraq or suffer the plagues of God’s wrath. He told President Bush and the rest of us to "watch the Weather". These words came to mind as I watched the hearings leading up to the financial bailout packages for AIG, one of the largest insurance companies in the world. Immediately, the picture of those Black people on rooftops in New Orleans in September of 2005 after Hurricane Katrina, flashed to my mind. As a result of the devastation of Katrina over $40 billion in insurance claims had to be settled by the various insurance companies of which AIG had to pay out $1.5 billion to policy holders for damages from Hurricanes Katrina and Rita.

In the weeks after Katrina AIG president, Martin Sullivan, stated: "Although reinsurance capacity could be constrained in the near future, AIG has the capital and financial resources to respond to our customers' needs." However, in 2008 AIG was one of the first in line to receive federal bailout funds to the tune of $125 billion.

But before the bailout, how did AIG and other insurance companies expect to improve their "reinsurance capacity"? After Hurricane Katrina, insurers began using a new risk formula that increased the projected short-term losses in coastal areas such as the Gulf Coast. That meant higher rates for homeowners.

From 2001 to 2006 home insurance premiums rose by 42.4% in Alabama, 77% in Florida, 65.2% in Louisiana, 63.3% in Mississippi and 50% in Texas. Since insurance premiums are based on the value of the home, the higher the value, the higher the premium. This has a deflationary influence on the overall housing market as people can not afford to buy the higher priced properties. So Katrina helped to deflate the housing bubble just by increasing insurance premiums.

Then in early December of this year, I watched on C-SPAN a presentation by economists from the Federal Reserve Bank of Boston (FRBB) trying to explain the relationship between mortgage delinquency rates and rates of house-price appreciation. The economists from the FRBB stated that their study showed a very strong negative correlation between recent rates of house-price appreciation and the level of the ‘subprime’ delinquency rate in 2006; that is, higher rates of house-price appreciation are associated with lower rates of delinquencies. Simply stated, as the value of houses are going up fewer people are delinquent on their payments and there are fewer mortgage defaults. The economists surmise that if the rate of growth in appreciation slows down or goes negative, many new mortgage holders will find that the value of their home has depreciated to a point that they owe more on the home than the home is worth, therefore they allow the home to go into foreclosure.

The economists stated, that based on the data that bankers and investors had prior to 2006, there was no way to predict that home values would stop climbing. However, I remember what my pocket felt like in September of 2005 after gas rose from $2.00 per gallon in the spring of 2005 to over $3.00 per gallon after Katrina.

70% of the American workforce use cars and trucks to get to work. America runs on oil. Food, parts and other goods are hauled by trucks which get only 7 miles to the gallon. As fuel prices go up, the price of these other items eventually rise as well, which has a negative impact on the consumers’ purchasing power, therefore they have less money to pay on their mortgage. Interestingly, the Federal Reserve System economists do not include energy costs and food prices into their measure of the Consumer Price Index (CPI), which they use to monitor inflation. Therefore, the data was there for them to see the impending storm that a severe rise in fuel prices would cause in the housing market, but they just refused to look.

In a May 2008 study entitled "Driven to the Brink: How the Gas Price Spike Popped the Housing Bubble and Devalued the Suburbs," economist Joe Cortright states: "The rise in gas prices from less than $1.10 in early 2002 to more than $3 today has dealt a major blow to consumer purchasing power and weighs most heavily on those metropolitan areas and those suburbs where people have to drive the farthest."

He pointed out that in metropolitan areas like Chicago, Los Angeles, Pittsburgh, Portland and Tampa, home prices have fallen more in farther-flung ZIP codes than in close-in neighborhoods. For instance, in Chicago, while housing prices have remained stable in close-in neighborhoods within three miles of the city’s central business district over the past 12 months, home prices have fallen 4% in "distant" neighborhoods 13 miles from the central business district. And in Los Angeles, while home prices have dropped 6% in close-in neighborhoods, they have decreased 10% in distant neighborhoods, according to the report.

I went to the Internet and pulled down historical data on crude oil prices from 1973 to 2007 and on the year to year percentage change in the median price of family homes from 1970 to 2008. In the early 1970s oil was relatively cheap, less than $10 per barrel. Home prices in the 70s appreciated at about 8% per year. However, the Iran-Iraq war started in September of 1980 and oil prices shot up in 1981 to over $30 per barrel and stayed there through 1985. Home price increases dropped to almost 0% in 1981 and stayed below 4% until 1986 when oil prices dropped to $11 per barrel. Home price increases fluctuated between 4% and 8% from 1986 to 1990, but when Iraq invaded Kuwait in August of 1990 and oil prices jumped up to over $30 per barrel, home prices decreased by a negative 2% by the end of the year.

The Federal Reserve economists knew that the Federal government had relaxed its control over oil price speculation as a result of the Commodity Futures Modernization Act of 2000. Therefore any jolt to the flow of oil due to wars, accidents or weather could cause wide swings in oil prices.

What should the economists at the Federal Reserve have expected when oil reached $45 per barrel after Hurricane Ivan in 2004 tore up the Gulf of Mexico’s oil rigs and refineries? Then the soft, oil rich, underbelly of America was hit again when Hurricanes Dennis, Katrina and Rita hit the Gulf of Mexico in 2005. The speculators drove the price of oil up to near $70 per barrel.

In the beginning of 2005 housing prices were accelerating at a national rate of 16%, but by 2006 had fallen to -1.5%. In 2007 housing prices fell by an unprecedented -4% and still worse in 2008 by -8%. And since the Federal Reserve economists did not include energy costs in their predictive models, they were either flying blind to the impending collapse of the housing market or fooling the government officials and the public. This collapse had a ripple affect on financial markets, precipitating the collapse of America’s financial system and caused the American people to lose over $13 trillion in wealth.

FEMA found it difficult to save the poor victims of Katrina in New Orleans. Insurance companies found it difficult to pay the poor a fair price for their destroyed homes. The recovery agencies found it difficult to restore the lives of those refugees from Katrina, but it seems that Katrina has washed away the foundation on which the financial giants of America built their fortunes at the expense of the working poor. Now, the blinded giants of financial wealth are falling into a dark, seemingly, bottomless pit, dragging America down with them.