A Fistful of Dollars: Lobbying and the Financial Crisis

WP/09/287




A Fistful of Dollars: Lobbying and the
Financial Crisis

Deniz Igan, Prachi Mishra, and Thierry
Tressel

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© 2009 International Monetary Fund
WP/!"#$%&



IMF Working Paper



Research Department

A Fistful of Dollars: Lobbying and the Financial Crisis1

Prepared by Deniz Igan, Prachi Mishra, and Thierry Tressel

Authorized for distribution by Stijn Claessens

December 2009

Abstract

This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those
of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to
elicit comments and to further debate.


Using detailed information on lobbying and mortgage lending activities, we find that lenders lobbying
more on issues related to mortgage lending (i) had higher loan-to-income ratios, (ii) securitized more
intensively, and (iii) had faster growing portfolios. Ex-post, delinquency rates are higher in areas
where lobbyist’ lending grew faster and they experienced negative abnormal stock returns during key
crisis events. The findings are robust to (i) falsification tests using lobbying on issues unrelated to
mortgage lending, (ii) a difference-in-difference approach based on state-level laws, and (iii)
instrumental variables strategies. These results show that lobbying lenders engage in riskier lending.

JEL Classification Numbers: G21; P16
Keywords:
Lobbying; financial crises; mortgage lending
Author’s E-Mail Address:
DIgan@imf.org ; PMishra@imf.org ; TTressel@imf.org

1 We would like to thank Daron Acemoglu, Olivier Blanchard, Stijn Claessens, Chris Crowe, Giovanni
Dell’Ariccia, Raymond Fisman, Ben Friedman, Aart Kraay, Luc Laeven, Augustin Landier, Rodney Ludema,
Mauro Mastrogiacomo, Steven Ongena, Marcelo Pinheiro, Claudio Raddatz, David Romer, Amit Seru, Antonio
Spilimbergo, Iman van Lelyveld, Francesco Trebbi, and participants at the 2009 NBER Summer Institute,
Center for Analytical Finance (Indian School of Business) 2009 Summer Research Conference in Finance,
World Bank Macroeconomics Seminar, De Nederlandsche Bank 12th Annual Research Conference,
Wharton/FIRS/JFI Workshop on the Financial Crisis, IMF 10th Jacques Polak Annual Research Conference, and
IMF Research Brown Bag Seminar for useful discussions and suggestions. Sumit Aneja, Mattia Landoni, and
Lisa Kolovich provided excellent research assistance.

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Contents
Page
I. Introduction ............................................................................................................................4!
II. Related Literature ..................................................................................................................7!
III. Empirical Approach .............................................................................................................8!
A. Lobbying and Loan Characteristics ..........................................................................8!
B. Empirical Specifications .........................................................................................11!
IV. Data Description ................................................................................................................15!
A. Mortgage Lending ...................................................................................................15!
B. Lobbying .................................................................................................................16!
C. Other Data ...............................................................................................................16!
D. Construction of the Regressions Dataset ................................................................17!
E. Summary Statistics ..................................................................................................18!
V. Results .................................................................................................................................19!
A. Empirical Analysis of Loan-to-Income Ratio .........................................................20!
B. Falsification Tests ...................................................................................................20!
C. Difference-in-Difference Estimations .....................................................................21!
D. Instrumental Variable Regressions and GMM........................................................21!
E. Evidence on Lobbying and Securitization and Mortgage Credit Growth ...............22!
F. Lobbying and Delinquency Rates ............................................................................22!
G. Stock Price Returns during the Crisis .....................................................................24!
H. Discussion of Results ..............................................................................................25!
VI. Conclusion .........................................................................................................................26!

Tables
1a. Targeted Political Activity Campaign Contributions and Lobbying Expenditures ...........32
1b. Lobbying by Financial Institutions and Lenders' Associations .........................................32
2. Summary Statistics...............................................................................................................33
3. Effect of Lobbying on Loan-to-Income Ratio .....................................................................34
4. Effect of Lobbying Expenditures on Loan-to-Income Ratio ...............................................35
5. Effect of Lobbying on Loan-to-Income Ratio: Falsification Tests .....................................36
6. Effect of Specific Issues Lobbying Expenditures: Differnce-in-Difference Strategy .........37
7. Effect of Lobbying Expenditures on Loan-to-Income Ratio: Instrumental Variables ........38
8. Effect of Lobbying Expenditures on Loan-to-Income Ratio - System GMM .....................39
9. Effect of Lobbying Expenditures on Proportion of Loans Sold ..........................................40
10. Effect of Lobbying Expenditures on Credit Growth ..........................................................41
11.a. Effect of Lobbying on Loan Delinquency Rates .............................................................42
11b. Effect of Lobbying on Loan Delinquency Rates: Instrumental Variables .......................43
12. Lobbying and Abnormal Stock Returns ............................................................................44
13. Evidence Inconsistent with Alternative Explanation .........................................................45

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Figures
1. Lobbying ex/firm, by Sector, 2006 ......................................................................................46
2. Evolution of Lobbying Intensity (expenditures per firm) Over Time .................................46
3. Lending Standards ...............................................................................................................47
4. Securitization .......................................................................................................................47


Appendix ..................................................................................................................................48

Table
A1. List of Issues .....................................................................................................................63
A2 Lobbying Report Filed by Bear Stearns .............................................................................65
A3. Lobbying Report Filed by Bank of America ....................................................................67
A4. Effect of Lobbying on Loan-to-Income Ratio: Additional Robustness Checks ...............70

References ................................................................................................................................28

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I. ITRODUCTIO
On December 31, 2007, the Wall Street Journal reported that Ameriquest Mortgage and
Countrywide Financial, two of the largest mortgage lenders in the nation, spent respectively
$20.5 million and $8.7 million in political donations, campaign contributions, and lobbying
activities from 2002 through 2006.2 The sought outcome, according to the article, was the
defeat of anti-predatory lending legislation. In other words, timely regulatory response that
could have mitigated reckless lending practices and the consequent rise in delinquencies and
foreclosures was shut down by some mortgage lenders. Such anecdotal evidence suggests
that the political influence of the financial industry contributed to the 2007 mortgage crisis,
which, in the fall of 2008, generalized in the worst bout of financial instability since the
Great Depression.3 However, formal analysis of these assertions has so far remained scant. 4

To the best of our knowledge, this is the first study to examine empirically the relationship
between lobbying by financial institutions and mortgage lending in the run-up to the financial
crisis. We construct a unique dataset combining information on mortgage lending activities
and lobbying at the federal level by the financial industry. By going through individual
lobbying reports, we identify lobbying activities on issues specifically related to rules and
regulations of consumer protection in mortgage lending, underwriting standards, and
securities laws (henceforth, the “specific issues”).5
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-
taking6). Next, we analyze measures of ex-post performance of lobbying lenders. In
particular, we explore whether, at the Metropolitan Statistical Area (MSA) level, delinquency
rates – an indicator of loan quality - are associated with the expansion of lobbying lenders’
mortgage lending. We also carry out an event study during key episodes of the financial

2 Simpson, Glenn, 2008, “Lender Lobbying Blitz Abetted Mortgage Mess,” The Wall Street Journal, December
31; available at http://online.wsj.com/public/article_print/SB119906606162358773.html. See also the Financial
Times front page coverage of the Center for Public Integrity study linking subprime originators (a large share of
which are now bankrupt) to lobbying efforts to prevent tighter regulations of the subprime market (May 06,
2009, “U.S. banks spent $370 million to fight rules”, May 06, 2009, available at:
http://www.ft.com/cfms/s/0/a299a06e-3a9f-11de-8a2d-00144feabdc0.html?nclick_check=1).
3 For a detailed account of the subprime crisis, see Gorton (2008a, 2008b). For a discussion of the mechanisms
underlying the various phases of the crisis, see Diamond and Rajan (2009).
4 Mian, Sufi and Trebbi (forthcoming) focus on the congressional voting behavior on key two pieces of
legislation that shaped the policy responses in the U.S. to the current financial crisis.
5 A sample lobbying report, shown in the appendix Table A2, filed by Bear Stearns and Co. to the Senate for
Public Records (SOPR) documents that the company lobbied to change regulations related to mortgage lending
standards for the period January-June 2007.
6 For an analysis of the correlation between fast credit growth and risk, see Dell’Ariccia and Marquez (2006).

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crisis to assess whether the stocks of lobbying lenders performed differently from 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. 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, (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.

We perform a number of tests to mitigate omitted variables and reverse causality concerns.
First, we conduct falsification tests by exploiting information about lobbying on financial
issues that are unrelated to mortgage lending and securitization. Next, we adopt a difference-
in-difference strategy to test whether the characteristics of mortgage loans originated by
lobbying lenders respond differently to the introduction of anti-predatory lending laws at the
state level, than those originated by other lenders. Finally, we adopt instrumental variable
strategies using as instruments the lags of explanatory variables, and the distance between the
headquarters of the financial institution and Washington, D.C., which is exogenous and
proxies for the cost of lobbying. The main findings are robust to these alternative
identification strategies.

Our findings indicate that lobbying is associated ex-ante with more risk-taking and ex-post
with worse performance. This is consistent with several explanations, including a moral
hazard interpretation whereby lenders take up risky lending strategies because they engage
in specialized rent-seeking and expect preferential treatment associated with lobbying.7 Such
preferential treatment could be a higher probability of being bailed out, potentially under less
stringent conditions, in the event of a financial crisis.8 Another source of moral hazard could
be “short-termism”, whereby lenders lobby to create a regulatory environment that allows
them exploit short-term gains.9 Such distortions have been claimed to be related to risk-

7 An extreme version of moral hazard would materialize if the financial industry was, for all practical purposes,
setting its own regulations. Another possibility is that some financial institutions have the specific expertise to
get markets out of the crisis, which makes any threat of punishment incredible, encouraging risky behavior
(Acemoglu, 2009).
8 In the current crisis, sixteen of the twenty lenders that spent the most on lobbying between 2000 and 2006
received funds provided by the government under the Emergency Economic Stabilization Act, including the
Troubled Assets Program, and the Housing and Economic Recovery Act. In total, lenders that lobbied on
specific issues received almost 60 percent of the funds allocated.
9 See, for instance, Bolton, Scheinkman and Xiong (2006) for a theory of optimal executive compensation
inducing managers to favor speculative components of stock prices. Calomiris (2008) provides an overview of
incentive problems during the housing market boom. Cheng, Hong, and Scheinkman (2009) report that short-
termism is empirically linked to risk-taking.

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shifting in financial markets. Under the moral hazard interpretation, misallocation of
resources can occur and it might be socially optimal to curtail lobbying or use public
oversight to realign incentives.

Yet, other explanations are also consistent with our results and they might entail radically
different policy conclusions. First, “bad” lenders could lobby more to mimic “good” lenders
and choose riskier lending strategies ex ante resulting in worse outcomes ex post. Second,
lobbying lenders may specialize in catering to borrowers with lower income levels and
originate mortgages that appear riskier ex ante, with a higher incidence of default in a
downturn. In this case, our findings would not necessarily indicate lower credit standards but
capture the specialization of the lender. Third, overoptimistic lenders may lobby more
intensively against a tightening of lending laws to exploit expected profit opportunities
because they underestimate the likelihood of adverse events.10 As opposed to the moral
hazard interpretation, under these explanations, it is possible that financial institutions lobby
to reveal information or promote innovation rather than engage in rent-seeking.

While these explanations cannot be definitely ruled out, various tests suggest that they may
be less likely to be valid. These tests consist of the inclusion of lender and time-varying area
fixed effects; explicit controls for specialization (e.g. whether the lender is subprime, or is
regulated by HUD); falsification tests based on lobbying for financial issues unrelated to
mortgage lending and securitization; regressions uncovering a differential effect of lobbying
on ex-ante lending standards after 2004, when important regulatory changes affecting
securitization and loan standards took place; and regressions showing a differential effect of
lobbying on ex-ante lending characteristics and ex-post performance for larger lenders, in
line with “too-big-to-fail” arguments.

The results imply that lending behavior is to some extent affected by politics of special
interest groups. They provide suggestive evidence that the political influence of the financial
industry might have the potential to have an impact on financial stability.11 However, it
should be recognized that it is hard to distinguish whether it is rent-seeking or information-
revealing that drives lobbying by the financial industry, hence policy implications should be
taken cautiously.

The rest of the paper is organized as follows. Section II discusses the related literature.
Section III outlines the empirical strategy. Section IV describes the dataset. Section V
presents the results and Section VI concludes.

II. RELATED LITERATURE
Since the pioneering work by Krueger (1974), rent seeking has been identified as a key
activity of economic agents in market economies. Lobbying – broadly defined as a legal

10 See, for instance, Van den Steen (2004) for how overoptimism can emerge in a rational framework.
11 See Johnson (2009) for a similar view.

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activity aiming at changing existing rules or policies or procuring individual benefits – is a
common form of rent-seeking activity in developed countries.12 Building upon the private-
interest theories of regulation (Stigler, 1971, and Becker, 1983), research on lobbying has
developed into two broad strands: studies that focus on the relationship between lobbying
activities and specific policies (see, for instance, Grossman and Helpman, 1994, Goldberg
and Maggi, 1999, and Ludema, Mayda, and Mishra, 2009, for the case of trade policy,
Facchini, Mayda and Mishra, 2008, for the case of immigration policy, and Kroszner and
Stratmann, 1998, for financial services) and those that aim to explore the consequences of
rent-seeking activity by special interest groups for firm-specific economic outcomes (see, for
example, Bertrand et al., 2004, and Claessens et al., 2008). Issues specific to banking and
finance have been studied by, among others, Kroszner and Strahan (1999), who show that
special interest theory can explain the design and timing of bank regulation in the U.S.; and
Kwahja and Mian (2005), who find that in Pakistan politically-connected firms obtain
exclusive loans from public banks and have much higher default rates. Our study, focusing
on lobbying and lending behavior, fits more closely in the second strand.

Our paper is also related to the emerging literature on the current crisis. This literature has
characterized the evolution of lending standards and the potential contribution of distorted
incentives in affecting the supply of credit, but has so far ignored the role of political
economy factors. Mayer, Pence and Sherlund (2009) show that subprime lending grew
extremely fast between 2001 and 2006, and that no-documentation, no down-payment loans
represented a large share of these loans. Mian and Sufi (2008) analyze the contribution of
subprime lending to the expansion of mortgage credit and its impact on default rates, and
show that the expansion in mortgage credit to subprime zip codes is closely correlated with
the increase in securitization, a finding consistent with distorted incentives in mortgage
lending. Keys et al. (2009) provide microeconomic evidence of moral hazard associated with
securitization of high-cost mortgages. Dell’Ariccia, Igan, and Laeven (2008) provide
evidence that areas in which lenders relaxed lending standards more also experienced larger
increases in subprime delinquency rates, and that the relaxation of lending standards was
associated with the recent entry of large lenders. Regarding the role of short-termism, there
is, so far, no consensus on whether distortions in compensation contracts contributed to
excessive risk-taking, with some positive evidence (Agarwal and Wang, 2009; Cheng, Hong,
and Scheinkman, 2009) being matched by negative evidence (Fahlenbrach and Stulz, 2009).

Overall, there remains scarce evidence in the literature on the political economy of the
current financial crisis. Igan and Landoni (2008) study the relationship between anti-
predatory lending laws and campaign contributions and show that contributions increase after
a law comes into effect. Mian, Sufi and Trebbi (forthcoming) focus on the consequences of

12 In developing countries, rent seeking by firms is more often performed through personal connections with
politicians providing various private benefits to firm owners (Fisman,2001, Johnson and Mitton, 2003, and
Faccio and Parsley, 2006), and can materialize through a variety of channels (preferential access to credit, bail-
out guarantees, privileged access to licenses, procurement contracts, etc.). Harstad and Svensson (2008)
develop a theory of endogenous evolution of corruption and lobbying over the development process: in less
developed countries, firms tend to rely on corruption to bend the rules, while, in richer countries, they choose to
lobby the government to change the rules.

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financial crisis and show that constituent and special interests theories explain voting on key
bills in 2008. In contrast to these papers, we study the role of political economy factors in
shaping lending standards during the credit boom and their impact on loan outcomes during
the crisis.

III. EMPIRICAL APPROACH
In this section, we first lay out some basic relationships between lenders’ lobbying and
lending to motivate the empirical specification. Next, we describe the empirical strategies
employed in the paper.
A. Lobbying and Loan Characteristics
Framework

We consider a simple framework relating lobbying to loan characteristics. A lender i among
a set of n lenders can lobby to influence the policymaker or to credibly signal information on
the mortgage loan market.13 A given contribution level lobbying
is chosen by lobbyist
i ! pol "
i to maximize his welfare, taking the contribution schedules of other lobbyists as given, and
anticipating that the policymaker chooses the policy pol :

lobbying pol ) # * B +$ *C +% *lobbying
pol + & * pol +' (1)
i !
"
i
i
(i !
"
i
where lobbying is either a dummy variable equal to 1 or the lobbying expenditures if a firm
i
lobbies and equal to zero otherwise; the contribution schedules of other lobbyists are
summarized in the vector lobbying ( pol) ; B is a vector of lender-specific benefits of
(i
i
lobbying; C is the cost associated with lobbying which we assume to be exogenous and '
i
i
is an error term. 14

In response to lobbying activities of lenders, the policymaker chooses a policy level that
maximizes his welfare.15 In equilibrium, policy depends on lobbying activities of all agents:


13 The basic relationships we present are very general and consistent with the two sets of existing theories of
lobbying: (i) common agency theories in which lobbying firms compete for influence over a policy by
strategically choosing their contribution to politicians (Bernheim and Whinston, 1986; and Grossman and
Helpman, 1994) and (ii) information-based theories in which lobbying firms have better information than the
policymakers and partly reveal their information by endogenously choosing their lobbying effort (Potters and
van Winden, 1992; Lohmann, 1995; Grossman and Helpman, 2001).
14 C captures the fact that a dollar spent on lobbying may be more or less effective in influencing the
i
policymaker depending, for instance, on political connections of CEOs and of board members, on the choice of
the lobbyist hired, or on the geographical proximity to Washington, D.C.
15 In the Grossman and Helpman (1994) framework, the welfare of the policymaker is a function of political
contributions and social welfare.

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pol ) , *lobbying + - *lobbying (2)
i
(i
We assume that characteristics of mortgage loans originated by lender i - including ex-ante
characteristics, such as the loan-to-income ratio and the probability of securitization, as well
as ex-post characteristics, such as delinquency rates– are related to (i) a set of average
borrower characteristics Z , (ii) lender characteristics X , (iii) policies, and (iv) lobbying
i
i
expenditures:
loan ) . * Z +/ * X + 0 * pol + 1 *lobbying +$
(3)
i
i
i
i
i
where loan is a vector of average loan characteristics of lender i , and $ is a residual.
i
i
Combining with equation (2) leads to the following equation in which lobbying is associated
with loan both directly (1 ) and indirectly through changes in policies ( 0, ):
i




loan ) . * Z +/ * X + 0, +1 *lobbying + 2
(4)
i
i
i
!
"
i
i
where 2 is an error term capturing unobserved factors influencing loan characteristics.16
i

Possible interpretations

Lobbying could be associated with loan characteristics for several reasons. First, lobbying
could affect loan characteristics directly if lenders lobby the policymaker because they expect
preferential treatment – for example, a higher probability of being bailed out in the event of a
financial crisis, or a lower probability of scrutiny by bank supervisors (coefficient 1 in
equations (3) and (4)). This in turn could lead to moral hazard and induce lenders to
originate loans that would appear riskier ex ante.17 Moreover, assuming all else equal, these
loans would have a higher probability of default ex post.

In another form of preferential treatment, lobbying buys access to policymakers. Such access
could increase lender’s franchise value by enhancing its reputation and providing publicity.
In that case, however, there is little reason to expect lobbying lenders to make riskier loans
and have higher default rates especially if enhancing franchise value is linked to long-term
value maximization.

Lobbying could also be indirectly associated with loan characteristics through its potential
effect on the regulatory environment (coefficient 0, in equation (4)). Various
interpretations, with different implications for the sign of the relationship between lobbying
and lending, can be captured through this channel.


16 Note that lobbying by other lenders is now included in this error term. Endogeneity concerns that may be
introduced by this are addressed in the econometric analysis.
17 See Tressel and Verdier (2009) for a model of political connections of banks emphasizing this moral hazard
channel.

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