Q&A: Justin Marlowe on Rebuilding Los Angeles After the Wildfires

Justin Marlowe is a Research Professor in the University of Chicago Harris School of Public Policy, where he also serves as Director of the Center for Municipal Finance. His research and teaching are focused on public finance, with emphasis on public capital markets, infrastructure finance, state and local budgeting, and financial disclosure.

As a series of wildfires have swept across Southern California since early January, damaging property and killing at least 29 people, questions have arisen about rebuilding Los Angeles and the surrounding area. We sat down with Professor Marlowe to learn more about how to do it – and whether we should rebuild at all:

We’ve seen footage of the devastation. Can you help us put the damage in perspective?

The residential component of large parts of Los Angeles is gone or is under threat, and authorities are still assessing the extent of the damage to public infrastructure.

We've been carefully watching the market's reaction to this, which I think is a pretty good initial answer to that question, "How are investors thinking about the rebuild based on what they're buying and selling right now?" Debt issuers have seen the spreads on the yields on their bonds increase something like 75 basis points the last week. Compare that to Katrina, which wiped out the entire property tax base of the city of New Orleans for some time. The increase in spread was like 30 basis points for that.

To put it another way: in the eyes of investors, the damage from the wildfires is twice the devastation of what happened in Katrina.

What are the challenges to rebuilding?

There are a lot of them. First, we need to assess whether underground pipes are still intact and the state of electric utilities. Public buildings, parks, facilities, large parts of the electric utility are now either under question or are going to have to be managed differently. There’s no question that you’re talking about infrastructure at large being either damaged or rendered completely useless.

There’s also the question of fire insurance. Despite a budget surplus several years ago, COVID-19 and other budget priorities have led the California state insurance program to be undercapitalized already. Now, after the destruction, it’s hard to envision insurers offering rates that people could afford.  Absent state intervention of some kind, the fund is going to be essentially wiped out.

Another challenge, and a major one, is financing a rebuild, from a market perspective. I think that's a huge open question right now. I don't know that a lot of the issuers in Los Angeles would be able to borrow at the yields that the market is telling them they would need to borrow at right now. Or if they did, they would have to significantly scale back their plans to rebuild.

It remains to be seen how the federal government and state of California and others will intervene, but there's no question that it's going to be a rebuild at a scale we've never seen before, especially given where the bond market is today.

But they were able to rebuild following Katrina. Is the difference just that more area was affected?

Certainly the geographic area in California is larger, but it’s really a double whammy: it’s more area, plus the properties and the structures on them are (or were) very valuable.

That’s very different than Katrina. The entire property tax base of New Orleans was effectively wiped out for some time. I think the hope in New Orleans was that following the cleanup and rebuild, you could improve property values, creating more opportunities. And investors could look at that tax base and think that it’s going to increase in value.

That’s not the case in Southern California. In some sense, there’s nowhere for property values to go in Los Angeles but down.

How long before Los Angeles can return from the ashes, so to speak?

In Southern California, wildfires are a fact of life, and they are now increasingly more intense. In New Orleans, there was a concerted effort to try to be better prepared for the next big storm – strengthening the levees, for instance. But storms on the scale of Katrina don’t happen all that regularly.

In Los Angeles, officials need to be honest with themselves and say, "What does it mean to rebuild? What is the smart way to rebuild? Should we rebuild in certain areas?" There was no question that you would rebuild New Orleans, but it’s not yet a settled issue that you want to rebuild everything lost in Los Angeles.

For the neighborhoods most directly affected by this, it’s going to take months and months just to sort out what a rebuild looks like. It's going to be a long, difficult process. And again, that assumes that everybody wants to come back, which may or may not be the case here.

It’ll take three to five years, most likely. But this is a real opportunity for the people to rethink their transportation systems, rethink the structure of the city, like Chicago did after its Great Fire.

What are the investors saying about whether and how to rebuild?

There are many people in the municipal bond market especially that have been saying for some time that there was going to be a major disaster on a scale like this.

There have been a lot of disasters: big earthquakes, the Santa Rosa fires, the list goes on. Since Katrina, the first time any of us saw a whole city destroyed by a natural disaster, many in the industry have been saying that at some point, there's going to be a disaster that will raise the question of whether the community can afford to rebuild, whether you can actually finance the rebuilding with the tools available.

North Carolina is going to struggle for a while, but they'll figure it out and there's insurance and there's FEMA dollars, and there's other ways that they will find their way through it. It might take time, but there's enough money in the system, so to speak, to facilitate that kind of a rebuild.

I don't know that there's enough insurance money, FEMA money, state money, other individuals being willing to pay out of pocket, to rebuild Los Angeles.

Where does the money come from?

This is where municipal finance can really shine, and where local governments can really make good things happen. They can borrow for very special localized needs, at competitive rates, and they can draw a lot of new investors into the mix. This is where the local capital markets are really well-equipped.

But for that to happen, the federal government needs to partner with those local governments at a scale that hasn't happened before. Whether the federal government will go along with that remains the big question. But it is that moment, and there's a lot of people in the municipal bond market that are saying, "If you've ever needed proof of why the municipal bond market is important, why these markets are essential for the health and well-being of people on the ground, this is the time. You want to rebuild? You're going to have to rebuild with municipal bonds."

Is Los Angeles too big and too expensive to rebuild? People in the municipal bond market would say, emphatically, "No, this market is up to that task." We can go out and we can find buyers for all of those bonds – but there's going to have to be some help to make it worthwhile for investors to come in, because it's a very different investment than it was a month ago.