A Fistful of Dollars: Lobbying and the Financial Crisis
“These results suggest that lobbying may be linked to lenders expecting special treatments from policymakers, allowing them to engage in riskier lending behavior.”
Abstract (Via IMF)
Has lobbying by financial institutions contributed to the financial crisis? This paper uses detailed information on financial institutions’ lobbying and their mortgage lending activities to answer this question. We find that, during 2000-07, lenders lobbying more intensively on specific issues related to mortgage lending (such as consumer protection laws) and securitization (i) originated mortgages with higher loan-to-income ratios, (ii) securitized a faster growing proportion of their loans, and (iii) had faster growing loan portfolios. Ex-post, delinquency rates are higher in areas where lobbying lenders’ mortgage lending grew faster. These lenders also experienced negative abnormal stock returns during key events of the crisis. The findings are robust to (i) falsification tests using information on lobbying activities on financial sector issues unrelated to mortgage lending, (ii) instrumental variables strategies, and (iii) a difference-in-difference approach based on state-level lending laws. These results suggest that lobbying may be linked to lenders expecting special treatments from policymakers, allowing them to engage in riskier lending behavior.
Introduction (Via IMF)
The paper focuses on the mortgage lending behavior and performance of financial institutions. First, we analyze the relationship between lobbying and ex-ante characteristics of loans originated. We focus on three measures of mortgage lending: loan-to-income ratio (which we consider as a proxy for lending standards), proportion of loans sold (measuring recourse to securitization), and mortgage loan growth rates (positively correlated with risk-taking5). Next, we analyze measures of ex-post performance of lobbying lenders. In particular, we explore whether delinquency rates at the MSA level – an indicator of loan quality – are associated with the expansion of lobbying lenders’ market share. We also carry out an event study during key episodes of the financial crisis to assess whether the stocks of lobbying lenders performed differently than those of other financial institutions.
Our analysis establishes that financial intermediaries’ lobbying activities on specific issues are significantly related to both their mortgage lending behavior and their ex-post performance. We find that, after controlling for unobserved lender and area characteristics as well as changes over time in the macroeconomic and local conditions, lenders that lobby more intensively (i) originate mortgages with higher loan-to-income ratios, especially after 2004; (ii) securitize a faster growing proportion of loans originated; and (iii) have faster growing mortgage loan portfolios. Our analysis of ex-post performance comprises two pieces of evidence: (i) faster relative growth of mortgage loans by lobbying lenders is associated with higher ex-post default rates at the MSA level in 2008; and (ii) lobbying lenders experienced negative abnormal stock returns during the main events of the financial crisis in 2007 and 2008.
Miguel’s Favorite Findings (Via IMF)
Ex post, delinquency rates are higher in areas in which lobbying lenders’ mortgage lending grew faster, and, during key events of the crisis, these lenders experienced negative abnormal stock returns. These findings seem to be consistent with a moral hazard interpretation whereby financial intermediaries lobby to obtain private benefits, making loans under less stringent terms. Moral hazard could emerge because they expect to be bailed out when losses amount during a financial crisis or because they privilege short-term gains over long-term profits. With the caveat that overoptimism might also be consistent with some of the findings, our analysis suggests that the political influence of the financial industry can be a source of systemic risk. Therefore, it provides some support to the view that the prevention of future crises might require weakening political influence of the financial industry.