The Guru Is In
Political risk insurance
By David A. Smith
5 min read
Acertain $10-billion-a-year industry faces systemic catastrophic risk, for which we are entirely uninsured.
Today’s tax credit properties would not exist without insurance. Today, a LIHTC property without insurance is unfinanceable and un-ownable. It must have title insurance, fire insurance, casualty and personal injury insurance, and flood insurance if relevant. Many properties expect the tenants to buy renter’s insurance, many loans have mortgage insurance.
Not only is insurance mandatory, its basic proposition is sensible: for each type of insurance, the property owner also owns a catastrophic risk, one that could wipe out the owner’s value entirely. So the entity sells the risk to a well-capitalized and collectible counterparty and pays the counterparty a fee (the premium), up front or annually, for the counterparty’s willingness to take on the risk. Insurance thus swaps a broad macro risk (that something bad will happen to us) for a discrete counterparty risk (that our insurance company won’t pay up if it does).
Yet there’s one catastrophic risk to which we have no insurance whatsoever: political risk.
Political risk: a practical definition
Political risk is the possibility that a government entity breaches its contractual obligations to a private party and cannot be held accountable.
Common forms of political risk include political violence; governmental expropriation or confiscation of assets; governmental frustration, abrogation, or repudiation of contracts; business interruption; or freezing of currency or assets.
Political risk is by definition non-commercial risk; unlike commercial risk, which is present between private parties, it arises only when the contractual counterparty is a sovereign government.
The LIHTC industry has no insurance against political risk … which is rising. Its absence is more perplexing and ironic when one realizes that Republicans who campaigned on cost-cutting initiatives now control both the House and Senate. The President is a lame-duck facing rebellions within his own party. Washington is abuzz with talk of ‘tax reform’, and various influential members of Congress (e.g. Messrs. Camp, Ryan, and Hensarling) have each launched proposals to simplify the tax code as part and parcel of lowering middle-class tax brackets and cutting the deficit. That’s serious political risk, and it’s rising.
“It can’t happen here … can it?” It’s tempting to consign political risk to the banana republics, yet the affordable housing field has experienced bouts of political risk, including:
- Cutting Annual Adjustment Factors (AAFs) on
Section 8 properties, a popular Congressional
appropriations pastime in the mid-1990s. - Repudiation of the owners’ right to prepay and go
market for HUD (1987-1996), and FmHA 515 properties (late 1980s to present). - De-funding Section 8 or delaying Section 8 payments,
by now an every-few-years occurrence.
Each time these political risks occurred, the industry was caught flat-footed and suffered.
How would the tax credit industry create political risk insurance? Though US domestic political risk insurance cannot be bought, we can make ourselves a better insurance risk by following the classic principles of risk minimization:
1. Mitigate risk (reduce probability of adverse event). Unlike most forms of insurance against the risk of Acts of God, here we care about Acts of Legislators (who may think themselves divine), and although we can’t stop them, we have to persuade them not to act against us, with activities such as these:
- Deliver and highlight tax credit properties in districts whose Members of Congress aren’t yet supporters. Don’t sell the sold, sell the unsold. Nothing flips a member’s vote like seeing a successful tax credit property back home, because a member who has not seen a tax credit property envisions an eyesore full of people who didn’t vote for him or her, and whereas who has seen it remembers community assets occupied by grateful constituents.
- Demonstrate that affordable housing is urban infrastructure. Instead of appealing to people’s charity, we should appeal to their self‐interest by casting affordable housing as an urban growth hormone that makes our cities work, our economy work, and our nation work, because affordable housing is where essential urban jobs go to sleep at night.
2. ‘Sell’ the risk to others who will also lose if it happens. When tax credit properties fail or when they’re not developed, it is not solely we who lose; state and local agency lenders lose value and purpose; cities and towns lose homes for working voters; large employers lose the people whose lower-end jobs make possible the high-end jobs. The more these folks realize this, the more they will get that though they may not care about LIHTC, they intensely care about affordable housing, which we produce.
3. Mitigate damage (reduce loss given adverse impact). Though repeal or cancellation of the LIHTC would seismically disrupt existing production pipelines, it wouldn’t kill the industry entirely, any more than did the 1986 tax-shelter extinction event. Because affordable housing is essential to modern American cities, if LIHTC goes away, something else must replace it. Inclusionary zoning, density bonuses, as-of-right or fast-tracked approvals of affordable infill, redeployment of surplus government property into affordable housing, and TIF financing are among the many non-federal resources and tools that today lie underused because the LIHTC’s dominance has dulled our perception of risk.
Too many conferences I attend conflate ‘affordable rental housing’ with ‘LIHTC production.’ That oversimplification is dangerous. We had better make sure it’s not fatal.
