In a rational world we'd invest to minimize the damage from a storm like Hurricane Sandy--I'm not holding my breath

11/02/2012 2:20 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Is this any way to run an economy?

In an efficient economy with a rational political class I’d be recommending shares of cement makers such as CEMEX (CX), and pump-makers Flowserve (FLS), and engineering companies such as Chicago Bridge & Iron (CBI) as post-Hurricane Sandy rebuilding plays.

But instead, casting a despairing eye on U.S. politics, I’m suggesting stocks such as Lumber Liquidators (LL) and Home Depot (HD). (For more on my reasons for buying Lumber Liquidators now see my post http://jubakpicks.com/2012/10/26/a-barbell-of-stock-picks-u-s-and-china-for-the-last-months-of-2012/ )

Investing in infrastructure to prevent some of the damage from the next Sandy would be the smart thing to do, but I think our political system is way, way past doing the smart thing.

In 1798 South Carolina Representative Robert Goodloe Harper could see off French threats to seize American ships unless the U.S. paid a bribe with the heroic “Millions for defense but not one penny for tribute.”

Today, our motto is more like “Millions in insurance payouts for new hardwood floors but not a cent for infrastructure.”

What will be the cost of Hurricane Sandy?

In human life so far, the toll is 61 dead in the United States as a result of the storm.

The consensus estimate of physical damage seems to be around $20 billion, although I’ve seen figures as low as $7 billion and as high as $40 billion. The actual total is very dependent on how much damage needs to be repaired in New York’s 108-year-old subway system. Big damage there could easily push the price tag above $40 billion. (By contrast last year’s Hurricane Irene cost $10 billion. Katrina in 2005 is estimated at $100 billion.) About $7 billion to $8 billion of the damage from Sandy is covered by insurance, estimates say.

The worst damage in Manhattan, where I live, came when a 13-foot storm surge swamped the southern end of the island. A giant transformer station at East 14th Street exploded, knocking out power to most of lower Manhattan. The water filled the Brooklyn-Battery tunnel and poured into the foundations of the under-construction World Trade Center and then backed up in the train tunnels under the Hudson. And, of course, water poured into the New York subway system. Early estimates were that it could take a week or more to pump out the system and restore full service. (The Metropolitan Transit Authority announced on October 31 that trains would start running in upper Manhattan on Thursday, November 1 And they did.)

The damage wasn’t limited to Manhattan. The storm knocked out power to 8 million households. Power outages and flooding caused sewage treatment plants throughout the region to fail and dump untreated sewage into rivers. In Howard County, Maryland, for example, the storm sent 2 million gallons of sewage an hour into the Little Pawtuxet River. In Atlantic City Hurricane Sandy ripped a huge hole in the city’s famed boardwalk. A fire in Breezy Point, Queens turned 111 houses into damp cinders. Hoboken, Newark, Jersey City, New Jersey all flooded. Hoboken’s mayor estimated that 20,000 people were stranded in their homes by floodwaters. Waves and high winds pushed the damage as far west as Chicago. In West Virginia Hurricane Sandy turned into a killer blizzard.

Nor was the damage limited to the United States. Hurricane Sandy destroyed 15,000 homes in Cuba. In the Dominican Republic 17,500 people were forced from their houses. More than 17,000 people had to be evacuated in Haiti.

Shots of row after row of cabs in Hoboken submerged in water to their windshields were reminders that the damage from the storm wasn’t limited to the destruction of property. Livelihoods, like each of these cabs, took brutal blows. In fact the economic damage from Sandy may actually turn out to be greater than the physical damage. The storm could cut economic activity in the fourth quarter by $25 billion, according to Global Insight. Wells Fargo put the hit to output at $30 billion. Some of this activity isn’t lost to the U.S. economy but simply delayed with Sandy reducing GDP by as much as 0.2 percentage points in the fourth quarter and then adding to growth in the first quarter of 2013.

A part of this damage could have been prevented. And some of it, on the economic numbers, is and was worth preventing. But deciding what is worth doing—in economic terms—is a matter of assumptions and arguments. And the arguments get louder the bigger the price tag for a project.

So, for example, the winds from Hurricane Sandy had barely died down before the talk about building sea gates revved up in New York. A 2004 study by the Storm Surge Research Group at the State University of New York at Stony Brook recommended building three sea gates—at the upper end of the East River near the Throgs Neck Bridge, under the Verrazano-Narrows bridge, and at the mouth of the Arthur Kill between Staten Island and New Jersey. That project would cost an estimated $10 billion. And at the time and for years afterwards, the biggest argument against spending that money was that no hurricane had made landfall directly in New York City for more than a century.

Sandy has changed this calculus. (As New York governor Andrew Cuomo has put it, after Irene and Sandy, New York seems to be experiencing a hundred-year storm every year or two.)

But I doubt that it has changed the calculus enough—yet. For spending $10 billion to make to economic and political sense, you have to assume that indeed something has changed in the global climate and that rising sea levels and warming of the air and water increase the frequency of big storms and make them more devastating when they occur. As you can tell from the total absence of climate change from the presidential campaign this year, we’re nowhere near a consensus on that issue. Heck, we’re not even having an intelligent discussion of the issue--despite the last minute attempt of New York's Mayor Michael Bloomberg to make it a campaign issue. (For an intelligent discussion of the statistics of climate change see Chapter 12 of Nate Silver’s new book The Signal and the Noise: Why So Many Predictions Fail—But Some Don’t. There are also scientists who worry about the effect of sea gates on the natural flushing of pollutants in New York’s coast waters and the effect on aquatic ecosystems. My guess is that if we ever do decide to build sea gates it will be done in a moment of panic and the attitude toward these objections will be “Aquatic ecosystems be damned. Full speed ahead.”)

But if we go down the price list, we pretty quickly get to territory where the cost of doing something to harden infrastructure—and not just in New York and environs because this same analysis with a different set of disasters and solutions can be found where you live—gets very reasonable versus the economic cost of doing nothing. The Metropolitan Transportation Authority, which operates the subways, has begun to spend money--$34 million in its recent budget—to raise ventilation grates, to design entrances to block floodwater from entering the system, and to increase pumping capacity. The agency could easily have spent more if the perennially cash-strapped system had more. Talk to any business in any boro of New York still without subway service today about how much that would be worth to them.

Consolidated Edison, our electric utility, estimates that installing submersible switches and moving high-voltage transformers above ground level would cost at least $250 million. In the aftermath of Sandy that seems like a bargain. The utility has spent about $24 million on changes like these in flood zones since 2007.

Go even further down the price list and I dare you to find a rational for doing nothing.

Take the case of Moonachie, New Jersey. The town, about 10-miles northwest of Manhattan, was inundated when a section of levy on the Hackensack River failed (or was simply overtopped by the tidal surge) and five feet of water poured into the town of 2,700 hundred. Flooding from this “break” also spread to Little Ferry and Carlstadt.

Read the October 24, 2005 Hackensack Meadowlands Floodplain Management Plan to see how incredibly predictable that was. The plan surveys areas subject to flooding in any kind of hard rain. For example, Carol Place in Moonachie experiences severe flooding during any large (2-year to 5-year) storm. Potential causes for minor flooding include lack of a pumping system and clogged catch basins. The cause of severe flooding in harder rains is, the report admits, “unknown.”

At Broad Street and 20th Street in Carlstadt, the report recommends the restoration of the Peach Island Creek Tide Gages to prevent tidal surges from moving up that creek. A diving company with experience in inspecting tide control systems should be hired to assess the extent of necessary repairs to the gates. The condition of the gate was “unknown” as of the time of the study.

Let’s see “Survey and repair tidal gates” versus “Pump water out of flooded town.” Yep, seems like the economics are pretty clear. I think you could compile a similar laundry list of disaster-related infrastructure investments in just about any part of the United States you’d like to name.

And in case you haven’t noticed, these examples, make it clear how “dumb” the current abstract debate about budget deficits is. Companies borrow money all the time to invest in their businesses and the issue isn’t whether borrowing another $100 million is “bad” or “good,” but what the return on the cost of the investment will be. Borrow $100 million to spend on upgrading furnishings in the executive suite—“bad.” Borrow $100 million to spending on new equipment that increases productivity—“good.”

Same thing in government at all levels. (Although I would argue that the problem gets larger the further away you move from local government and as the sums involved get bigger.)

Spend $823,000 for a General Services Administration “training” session in Las Vegas—“bad.”

Spend $823,000 to upgrade flood protection along the Hackensack River—good. Unless, of course, you think having the National Guard evacuate people from flooded homes in an economically devastated city is a “good” use of money if it is avoidable. (And note that borrowing at the Federal level is currently incredibly cheap. That's not a reason to borrow more but it sure does change how the “profit/loss” calculations on any investment come out.)

Of course, our national discussion of the end of 2012 fiscal cliff faced by the U.S. government isn’t going to include anything as radical as looking at return on investment. How could it when the country doesn’t even do a capital budget that treats investments as a separate category?

Instead we’re going to slash this program and spare that one based on what interest groups yell loudest. And which groups have contributed the most to the politicians best placed to influence the decision.

Maybe someday—after another devastating natural disaster of two in other parts of the country—the United States might invest in ways to prevent damage to its infrastructure. (Or even in improving our infrastructure.) But listening to the closing days of this election, I’m not counting on that happening anytime soon.

Meanwhile, dream of a world where economic logic decides where our tax dollars were spent—and buy shares of Lumber Liquidators.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of Lumber Liquidators as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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