Lobbying and the financial crisis
Quick Bit (Via Vox.eu):
Should the political influence of large financial institutions take some blame for the financial crisis? This column presents evidence that financial institutions lobbying on mortgage lending and securitisation issues were adopting riskier lending strategies. This contributed to the deterioration in credit quality and to the build-up of risks prior to the crisis.
Introduction (via Vox.eu):
Should the political influence of large financial institutions take some blame for the financial crisis? In his speech at the 2010 annual meeting of the American Economic Association, Fed Chairman Ben Bernanke argued that, based on evidence of declining lending standards during the boom, “stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates” (Bernanke 2010).
Why wasn’t financial regulation tightened before the crisis?
If regulatory action would have been an effective response to deteriorating lending standards, why didn’t the political process result in such an outcome? Questions about the political process, through which financial reforms are adopted, are very timely now that the US Congress is considering financial regulatory reform bills.
A recent study by Mian, Sufi and Trebbi (forthcoming) shows, for example, that constituent and special interests theories explain voting on key bills, such as the American Housing Rescue and Foreclosure Prevention Act of 2008 and the Emergency Economic Stabilization Act of 2008, that were passed as policy responses to the crisis.
A number of news articles have reported anecdotal evidence that, in the run up to the crisis, large financial institutions were strongly lobbying against certain proposed legal changes and prevented a tightening of regulations that might have contained reckless lending practices. For example, the Wall Street Journal reported on 31 December 2007 that Ameriquest Mortgage and Countrywide Financial spent millions of dollars in political donations, campaign contributions, and lobbying activities from 2002 through 2006 to defeat anti-predatory-lending legislation.
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What are the implications of these findings for policy making?
- Should lobbying be banned altogether because it is driven by rent-seeking?
- Is lobbying symptomatic of other underlying problems?
- Is lobbying, on the contrary, a channel through which lenders share their private information with policymakers?
With the benefit of hindsight, it seems reasonable to argue that lobbying by financial institutions can contribute to risk accumulation and threaten the stability of the financial system. Drawing precise policy implications, however, may not be straightforward, and would depend on the motives behind lobbying and lending practices.
Financial institutions may lobby to obtain private benefits, such as decreased scrutiny by bank supervisors, or higher likelihood of a bailout, and potentially under less stringent conditions. Under such rent-seeking motivations, lobbying is socially undesirable, all the more so as it contributes to financial instability. It should therefore be tightly regulated.
Lobbying may also reflect distorted short-term incentives within financial institutions; the perspective of high short-term gains may motivate both risk taking and lobbying. In this case, tackling the underlying distortion – by aligning managers’ compensation with long-term profit maximisation – may be a more efficient way to limit excessive risk-taking than preventing lobbying.