Hoover visiting fellow Matthew E. Kahn is the Provost Professor of Economics at the University of Southern California and the author of seven books, including Climatapolis: How Our Cities Will Thrive in the Hotter Future (Basic Books, 2010) and Adapting to Climate Change: Markets and the Management of an Uncertain Future (Yale University Press, 2021).
Why did the January 2025 Los Angeles fires cause so much damage? If we can learn the lessons from this shock, then we are less likely to repeat the mistakes. Since my explanation for the disaster has multiple “puzzle pieces,” I will first introduce each one and then discuss the ugly synergistic impacts of them together.
The California coastal boundary zone—Most of the Pacific Palisades, the devastated area near Malibu, lies inside the California coastal boundary zone (CBZ). This means that any redevelopment of homes in the area faces extra regulatory scrutiny. This acts as a disincentive to update housing to improve fire safety, among other changes. The average home in the Pacific Palisades was built in 1966! This old housing doesn’t feature modern technology. Here is a detailed discussion of the problem that I wrote with Ryan Vaughn and Jonathan Zasloff.
Proposition 13—This famous ballot initiative freezes incumbent property owners’ property taxes at artificially low rates. This has created an incentive for them not to sell their properties and for the owner to age in place. Thus, the Pacific Palisades area featured both older homes and older owners, whose departures otherwise would have created opportunities to upgrade the housing stock.
The California Fair Plan—This insurer of last resort is subsidized by the state. In recent years as for-profit insurers have stopped offering policies to homeowners in risky places, many individuals have turned to the Fair Plan. I will return to this point below.
California’s for-profit insurance markets—These are highly regulated, such that the state’s Insurance Commission must sign off on rate hikes. In the recent past, this agency has limited rate increases to no more than 7 percent per year. This price ceiling has caused insurers to retreat from the state, and this has nudged more property owners to rely on the subsidized Fair Plan.
Zoning—Much of the Los Angeles area (77 percent) is zoned for single-family residences. This binding constraint means taller buildings are not allowed to be built in areas deemed to be relatively safer.
Water prices are set by the Los Angeles Department of Water and Power—This municipal utility has not introduced widespread dynamic pricing, a market approach to allocating scarce water. If artificial intelligence were to identify regions most at risk of fire, there would be a crisis benefit of surplus water capacity in the right places to fight fires when those shocks materialized. Such a “rainy day fund” would focus on building water inventories ready to fight low-probability (but increasingly likely) disasters.
Vegetation—In retrospect, it’s clear that too little brush and fire-prone vegetation was cleared in areas facing fire risk. Did the California Endangered Species Act discourage investment in brush clearance out of fear of hurting creatures and plants? How have governments discouraged and even punished such fire-protective measures?
Fire departments—We don’t know much about how fire departments allocate labor and capital to tasks such as reducing the risk of extreme wildfires and fighting such fires. Did environmental regulations also reduce Southern California fire departments’ investments in pruning vegetation that could be wildfire fuel? Who settles the tradeoffs between protecting ecological habitats and reducing wildfire risk? How much extra wildfire risk has Southern California faced because of the success of environmental lawsuits in protecting habitats?
Now let’s look at how this all came together.
The combination of the state placing a price ceiling on for-profit insurance rates and the existence of the California Fair Plan creates an adverse selection effect as the riskiest properties turn to the Fair Plan for insurance. This has at least two economic effects. First, it means that the rest of California (including property owners in safe places, and renters around the state) are subsidizing those who choose to take a risk. Also, because the Fair Plan is not a for-profit, it faces weak incentives to encourage property owners in risky places to take costly self-precautions that would reduce wildfire risk.
Here is an essay where I present my “rules of the game” for unleashing for-profit insurers to be the “adult in the room” encouraging adaptation to risk. Here is another article examining how the insurance industry can help prepare for disasters.
The ugly synergy between the California coastal boundary zone and Proposition 13 is that older people are living in older homes in an increasingly risky place. They are not updating their homes to be ready for the new realities. If professional management companies were to own such land, they would have the data, expertise, and capital to finance this resilience and to work with the authorities to provide local public goods that together would lower fire risk.
I believe that the destruction of the Los Angeles fires would have been much less if the issues mentioned above had been addressed. I have sketched out the microeconomic approach to thinking through the regulatory synergies that together created the “kindling” so that a wildfire, once sparked, spreads and causes great damage. How will Southern California perform next time?
The answer depends on whether we change the rules of the game in response to this shock. Will there be a significant silver lining of regulatory reform?
