Making Friends

• Author: Deniz Igan and Prachi Mishra
• Position: and are Economts in the IMF's Research Department.

AT THE END OF 2007—as markets grappled with the early stages of what would become the worst financial crisis in the post–World War II era and a severe recession seized the U.S. economy—The Wall Street Journal reported that two of the largest mortgage lenders in the United States had spent millions of dollars on political donations, campaign contributions, and lobbying activities from 2002 through 2006 (Simpson, 2007).

Ameriquest Mortgage and Countrywide Financial fought anti-predatory-lending legislation in Georgia and New Jersey and fended off similar laws in other states and at the federal level, according to the Journal. In other words, the financial industry fought, and defeated, measures that might have allowed for a timely regulatory response to some of the reckless lending practices and consequent rise in delinquencies and foreclosures that most think played a pivotal role in igniting the crisis. The Center for Public Integrity—a nonprofit Washington, D.C.–based investigative reporting organization—in 2009 linked subprime originators, most of which are now bankrupt, to lobbying against tighter regulation of the mortgage market (Center for Public Integrity, 2009). In fact, banks continued to lobby intensively against tighter regulation and financial regulatory reform, even as the industry struggled financially and suffered from negative publicity regarding its role in the economic crisis (Labaton, 2009).

As these anecdotes suggest, regulatory failure, in which the political influence of the financial industry played a part, may have contributed to the 2007 meltdown in the U.S. mortgage market, which by fall 2008 had escalated from a localized U.S. crisis to the worst episode of global financial instability since the Great Depression of the 1930s.

To go beyond anecdotes and systematically study how much lobbying and campaign contributions affected U.S. financial legislation in the years preceding the crisis, we developed a new data set of U.S. financial companies’ politically targeted activities during 1999–2006 (Igan and Mishra, forthcoming). We found that lobbying expenditures by the U.S. financial industry were directly associated with how legislators voted on key bills in the years before the crisis—and that bills proposing regulation that the industry considered unfavorable were far less likely to pass than bills proposing financial deregulation. We chose to focus on the United States not because lobbying doesn’t take place in...