A Fistful of Dollars:Lobbying and the Financial Crisis

by Deniz Igan, Prachi Mishra,

and Thierry TresselIMF

NCAER , July 14, 2011

The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy.

MOTIVATION“[…] From 2002 through 2006, Ameriquest, its executives and their spouses and business associates donated at least $20.5 million to state and federal political groups. […] Ameriquest became a player in the business of lending to low-income homeowners. The company persuaded many homeowners to take cash out of their houses by refinancing them for larger amounts than their existing mortgages. […] Home loans made by Ameriquest and other subprime lenders are defaulting now in large numbers.”

(Wall Street Journal, December 31, 2007)

QUESTIONSI. Did lobbying lenders behave differently from non-

lobbying lenders during 1999-07? (ex-ante analysis) – riskier lending strategies

II. How did lobbying lenders perform in 2008? (ex-post analysis)– worse outcomes

III. Did lobbying lenders benefit more from the bailout program?

SUMMARY OF FINDINGSI. Lobbying associated ex-ante with more risk-taking.

(1) higher loan-to-income ratios, (2) higher securitization, (3) faster growing loan portfolios

II. Lobbying associated ex-post with worse performance(1) higher delinquency rates in 2008(2) negative abnormal returns during key events of the crisis

III. Bailout-program more favorable to lobbying lenders(1) stock prices increased more with announcement of bailout(2) more likely to be bailed out

INTERPRETATION OF FINDINGSLender characteristics that drive both lobbying and lending / certain lenders to benefit more from lobbying – specialized/overoptimistic (information motive for lobbying

e.g. against tighter regulation)– short-termist/corrupt (rent-seeking motive for lobbying e.g.

against tighter regulation/to get preferential treatment)

Lobby more intensively at time t; efforts successful; rules not tightened / under less scrutiny or have insurance– even if other lenders may “free-ride”

Allows these lenders to take more risks in t+1 – relatively bigger appetite for risk than non-lobbying lenders

Risky portfolio linked to worse loan outcomes

RELATED LITERATUREMian, Sufi and Trebbi (AER, 2010; 2010)– Constituent interests, special interests and ideology explain voting

patterns on two bills in 2008 / six bills during 2002-07

Igan, Mishra and Tressel, 2011– Different question– Novel lender-level dataset

disaggregate and precise measure of special interests

Igan and Mishra, 2011– Voting patterns on all financial-regulation-related bills– Special interests and network connections between politicians,

financial sector and lobbyists

CONTRIBUTION

First to examine empirically the relationship between lobbying and mortgage lending

Unique dataset combining detailed information on lobbying and lending at the lender level

DATA

Lending

Lobbying

DATA – LENDING Home Mortgage Disclosure Act (HMDA, 1975) Loan Application Registry

Data collapsed to lender-MSA-year level covering 1999-2007

Main variable of interest: – Loan-to-income ratio (LIR)

Other variables of interest– Proportion of loans securitized– Credit growth

DATA – LOBBYINGWe compile a unique dataset at the firm-level– Center for Responsive Politics (CRP) and Senate’s Office of

Public Records (SOPR) websites– 1999-2006

Under 1995 Lobbying and Disclosure Act, lobbyists must file semi-annual reports – List name of client and total income received from each client– Firms with in-house lobbying required to file total amount spent– Disclosure of issue category (76 categories)

We focus on 5 general issues – accounting, banking, bankruptcy, financial institutions and housing

– Specific issue with which the lobbying is associated (e.g. bills)

Table 1a. Targeted Political Activity Campaign Contributions and Lobbying Expenditures

(millions of dollars)

Election cycle1999-2000

2001-02

2003-04

2005-06

Overall lobbying expenditure 2972 3348 4081 4747Share of finance, insurance, and real estate industry FIRE in overall lobbying (in percent) 14.7 14.3 15.8 15.2

Contributions from PACs 326 348 461 509

Total targeted political activity 3298 3696 4542 5256

Firm-level lobbying constitutes 90 percent of targeted political activity

11

8

81

Match Statistics (Fraction of lender-MSA-year observations)

Lobby on specific issues related to mortgage marketsLobby on other issuesDo not lobby

Total number of lender-MSA-year observations (1999-2006)=650,000

Are lobbying lenders different?

Assets

(in lo

gs)

Market

share

of le

nder

Regula

tor is

HUD

Lend

er is

subp

rime

Loan

-to-in

come r

atio

Proport

ion of

loan

s sold

Growth

in loa

ns (in

perce

nt)

Bailou

t0

20406080

100120140160180

Lenders that lobby on specific issues 1999-2006 (index=100)Lenders that do not lobby on specific issues

EMPIRICAL ANALYSIS EX-ANTE ANALYSIS (1999-2007): Loan-to-income ratio (LIR) Securitization Credit growth

EX-POST PERFORMANCE (2008): Delinquency rates Event study with stock returns

BAILOUT PROGRAM (2008):Event study with stock returns Determinants of the likelihood of receiving bailout

Lenders that lobby for specific issues have higher LIR after controlling for area and lender characteristics and other factors

changing over time

Table 3. Lobbying and Loan-to-Income RatioDependent variable: LIR at (lender, MSA, year) level, 1999-07

[5] [6]Lobby dummy 0.145*** 0.142***Lobby on other issues dummy

-0.017***

MSA FE YesYesYesYes

YesYesYesYes

Year FEMSA*year FELender controlsObservations 648,938 648,938

This finding does not change in specifications with lender fixed effects…

Table 4: Lobbying Expenditures and LIRDependent variable: LIR at (lender, MSA, year) level, 2000-07

[1] [5]Log (lobby exp), lagged 0.007*** 0.002***Lender FE No YesMSA FE No YesYear FE No YesMSA*year FE No YesLender controls No YesObservations 406,035 406,035

Lenders that lobby tighten their lending standards more when an anti-predatory lending law is in place

Table 5: Lobbying Expenditures and LIR: Diff-in-DiffDependent variable: LIR at (lender, MSA, year) level,

2000-07[4]

Log (lobby exp), lagged 0.007***Dummy=1 if lending law 0.006Log (lobby exp), lagged*lending law -0.005***Lender FE YesMSA FE YesYear FE YesLender controls YesObservations 406,035

Lenders that lobby securitize larger proportion of loans and expand credit faster…

Table 6. Lobbying, Securitization and Credit GrowthDependent variables Proportion of

loans soldCredit growth

Log (Lobby exp) 0.007*** 0.321***Lender controls Yes YesLender FE Yes YesMSA FE Yes YesYear FE Yes YesMSA*year FE Yes YesObservations 406,035 406,996

Bottom line….

Lobbying is associated ex-ante with more risk-taking

LOBBYING & EX-POST PERFORMANCE

Delinquency rates in 2008 and lobbying at the MSA level–Growth in lobbying lenders market share in

the MSA during 2000-2006

Event study analysis on stock returns of lobbying lenders around key events of financial crisis

Areas where the lobbying lenders gained more market share have higher delinquency rates

Table 7. Lobbying and Loan Outcomes

Dependent variable: Delinquency rate at the MSA-level in 2008

Δ(market share) of lobbying lenders, 2000-06

0.718*** 0.734***

Δ(market share) of lobbying lenders, other issues

-0.032

MSA controls Yes Yes

Observations 305 305

Lenders that lobbied experienced negative abnormal returns during key events of the financial crisis

(1) March 11-16, 2008: JP Morgan acquires Bear Stearns after Fed provides $30 billion in

non-recourse funding; Fed expands liquidity provision(2) September 15-16, 2008: Lehman Brothers files for bankruptcy; AIG is bailed out

Table 12. Lobbying and Abnormal Stock Returns

Dependent variable: Market- and risk-adjusted stock return

(1) & (2) (2)

Bear Stearns and Lehman failures

Lehman failure

Lobbying dummy -0.210*** -0.369**

Lender controls Yes Yes

Event fixed effects Yes No

Observations 92 45

Bottom line….

Lobbying is associated ex-post with worse performance

LOBBYING & BAILOUT

Event study around announcement of the bailout program

Determinants of the likelihood of receiving bailout

Lenders that lobbied experienced positive abnormal returns when TARP was announced

(3) October 14, 2008: Troubled Asset Relief Program (TARP) making $700 billion available for asset purchases was announced.

Table 8. Lobbying and Abnormal Stock Returns

Dependent variable: Market- and risk-adjusted stock return

(3)

Bailout announcement

Lobbying dummy 0.274***

Lender controls Yes

Observations 45

Lenders that lobby more likely to be bailed out

Table 9. Lobbying and BailoutDependent variable D=1 if lender got funds

under TARP

Lobby dummy, 2000-06 0.069***Assets (in logs) 0.001***Market share of lender 0.079*Lender controls YesObservations 13,172

SUMMARY OF RESULTS

I. Lobbying was associated with more risk taking during 1999-2007

II. Lobbying was associated with worse performance in 2008

III. Markets anticipated lobbying lenders to benefit more from the 2008 bailout and they indeed did

FURTHER ROBUSTNESS CHECKS

Alternative measures of lobbying expenditures – split among specific issues by share of reports– include expenditures by associations– scaled by assets– scaled by importance of law and regulations

Alternative clustering of standard errorsDrop outliers

INTERPRETATIONLender characteristics that drive both decision to lobby and lending behavior

Certain lenders more to gain from relaxation of rules

Lobby more intensively at time t

Lobbying efforts successful and rules not tightened

Allows these lenders to take more risks in t+1

Given the risky portfolios, these lenders experience worse loan outcomes if hit by adverse shocks

Which lenders more likely to benefit more from lax regulation?

Information-based motives of lobbying (Grossman and Helpman, 2001)

Specialized lenders catering to riskier (e.g. low-income borrowers) lobby to signal private information on specialty Some evidence inconsistent with specialization story– regressions control for some specialization effects e.g.

whether lender is subprime, HUD regulated, area and lender characteristics;

– cannot exclude specialization on other dimensions

Which lenders more likely to benefit more from lax regulation? (contd.)

Information-based motives of lobbying (Grossman and Helpman, 2001)

Overoptimistic lenders, genuinely underestimate the likelihood of default and lobby to signal private information about the “true” state of the world

Which lenders more likely to benefit more from lax regulation? (contd.)

Rent seeking motives of lobbying (Grossman and Helpman, 1994)

Lenders with greater desire to exploit short-term gains at the expense of long-term profits lobby to prevent tightening of laws that may reduce benefits associated with short-termist strategies– induces moral hard

Which lenders more likely to benefit more from lax regulation? (contd.)

Rent seeking motives (contd.)“Corrupt” lenders lobby to increase chances of preferential treatment e.g. lower probability of scrutiny and even higher probability of getting bailed out in the event of a crisis– standard moral hazard; lobby to buy insurance

Some evidence inconsistent with this story– lobbying on any issue to establish connectedness; – falsification suggests otherwise – lobbying on unrelated

issues not positively associated with risk-taking

CONCLUSION Did lobbying lenders behave differently from non-lobbying ones during 1909-07, and how they performed in 2008?

First paper to study relationship between lobbying and lending in the run-up and during the crisis

Construct a unique database at lender-level combining information on loan characteristics and lobbying on regulations related to mortgage lending

Results consistent with both information-based and rent seeking motives for lobbying