Q&A Seven Questions about Political Influence and the Financial Crisis

• Author: Deniz Igan, Prachi Mishra, and Thierry Tressel
• Pages: 6-8

Page 6

Question 1: How did we get here?

Much has been said about the factors that paved the way to the worst financial crisis since the Great Depression. In recounting these factors, Claessens and others (2009) pay particular attention to regulatory failure. Regulators and supervisors have been accused of missing the warning signs and failing to take the necessary actions that would have contained the risks. Yet, an important piece of the puzzle as to why regulators failed seems to be missing. The political process of establishing the legal framework that gives supervisors the ability to guard financial stability is not immune from being influenced by the groups that are affected by this framework. In fact, these groups engage in targeted activities, through campaign contributions and lobbying, in order to impact policymaking.

For example, The Wall Street Journal reported on December 31, 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 (Simpson, 2007). Does this mean that timely regulatory response that could have mitigated reckless lending practices and the consequent rise in delinquencies and foreclosures was shut down by the industry? Such anecdotes suggest that the political influence of the financial industry contributed to the financial turmoil in subprime mortgages that started in the spring of 2007 and, since then, generalized into a full-blown credit crisis. Recent studies that involve formal analyses of the political economy of the crisis include Igan, Mishra, and Tressel (forthcoming) and Mian, Sufi, and Trebbi (forthcoming).

Question 2: What is lobbying and how does it work in the United States?

Since the 1970s, rent-seeking has been identified as a key activity of economic agents in market economies. In developing countries, rent-seeking by firms is more often performed through personal connections with politicians to obtain private benefits and can materialize through a variety of channels (preferential access to credit, bail-out guarantees, privileged access to licenses, procurement contracts, etc.). In developed countries, lobbying-broadly defined as a legal activity aiming at changing existing rules or policies or procuring individual benefits-is a common form of rent-seeking.

Lobbyists in the United States-often organized in special interest groups-can legally influence the policy formation process through two main channels. First, they offer campaign finance contributions, in...