"Kee Points" with Jim Kee, Ph.D.


  • Economics of Destruction
  • Harvey and Energy
  • Houston Municipal Bonds


The Economics of Natural (and other) Disasters

 

Hurricane Harvey impacts: In general, disasters like earthquakes, hurricanes, and tsunamis have a surprisingly limited impact on GDP, positive or negative, though you can find opinion to the contrary. The truth is that it really depends upon a lot of things, like where the economy and confidence are at the time of the disaster, the perceived competence of the response by authorities, etc. But in general, when a city like Houston - whose GDP is greater than that of 37 US states – is hit, there is the massive negative disruption of production and distribution activities (i.e. supply-chain effects). Offsetting that is the positive impact of rebuilding efforts. To assume that these latter rebuilding effects dominate; that is, that the effect of such massive destruction is a net positive, is to commit what is known in Econ 101 as “the broken window fallacy.”


Popularized by business journalist Henry Hazlitt in the 1940s, the broken window fallacy derives from the work of 18th century French economist Frederick Bastiat. Bastiat’s tale was of a shopkeeper’s son who happens to break a piece of glass. It is believed that the “six francs” that it cost to repair the damage “brings six francs to the glazier’s (glass tradesman) trade,” implying that breaking more windows generates more work and a larger economy. But of course the six francs comes out of the shopkeeper’s pocket, and it would have been used for something else (adding to that trade). Perhaps the shopkeeper was going to buy a new suite with his six francs, so the increased work to the glazier comes at the expense of the tailor, who sees six francs less work than otherwise. So the net effect, that is, the gain to the glazier minus the loss to the tailor (and the shopkeeper, who is out a suit), is basically zero. And here’s the lesson: The total output of the economy hasn’t changed, just its composition. That’s the way to basically think about the impacts of disasters like Hurricane Harvey, 2012’s Hurricane Sandy in New Jersey, the 2011 Japanese Tsunami (that killed 18,000), or even events like September 11th.


 


Impact on Texas


That view represents the long view, not the short. According to Christian Ledoux, our Director of Equity Research, about 15% of the nation’s oil refining capacity is down due to Harvey. Damage is reported to be minimal, but “best case scenario” is that it will take 7-10 days for the refineries to be up and running again; beneficiaries will be refiners with operations outside of the gulf coast. Interestingly, insurers are in far better financial shape than they were prior to Katrina (New Orleans) and Sandy (east coast), and evidentially some reinsurers are expecting the damage from Harvey to be below these two prior storms. Based upon what I’m hearing from Houston I find that a little hard to believe, but we’ll see. Of course, suppliers of everything from building materials to batteries will experience a temporary surge in business, but the value of a business is based upon its expected earnings over future years, so a short-term or temporary surge will just result in a blip in these companies’ stock prices at best.



Houston Municipal Bonds


What about Texas municipal bonds? According to Diederik Olijslager, our Senior Fixed Income Portfolio Manager (citing research by the Baker Group), only one municipal bond default occurred following Hurricane Katrina, which was the most destructive and costliest storm in US history (NOAA). He said public infrastructure, hospitals, public housing, water and sewer systems, and electric utilities will likely see high amounts of damage and disruption in the affected areas of Texas. And municipal bond debt service payments may be vulnerable to disruptions in those areas hardest hit. But given expected Federal (FEMA- Federal Emergency Management Agency) and State relief that is likely to be provided to local bond issuers, there is little chance of widespread bond defaults (in fact, this is a reason for cities to overstate damages). The immediate impact to municipal bonds in the affected regions will be a reduction in “credit cushion,” or credit protection, so credit ratings might be under some pressure in the near future as financial reassessments are made of bond issuers. In the near-term, bond prices may be impacted negatively as market participants attempt to reprice credit risk of impacted bond issuers, but we do not expect a long-term impact. As an aside, we at STMM had already lowered our exposure to Houston-area municipal bonds in recent years because of oil price declines.