The Wonk Room

As Financial Industry Gears Up, Report Shows Lobbying Led To Shoddier Loan Standards And More Losses

There are an array of reports today outlining the steps that the banking and financial services industries are taking to gum up various aspects of the plan to beef up Wall Street regulation.

There’s a new industry group — the Financial Instruments Reporting and Convergence Alliance (FIRCA) — fighting an accounting rule change meant “to end a practice that contributed to the risky lending that set off the financial crisis.” Hedge funds, organized into the Managed Funds Association, are mobilizing “money and power to fend off tougher oversight, higher taxes and much greater transparency.”

And of course, banks are continuing to raise a stink about the Obama administration’s plan to create a new consumer protection agency. All of which makes this report from the Research Department at the International Monetary Fund (IMF) (via The Stash) extremely timely.

The paper shows that the financial firms that did the most lobbying from 1998 to 2006 also had lower lending standards, a greater tendency to securitize, a larger presence in areas that are suffering the most from loan delinquencies, and ultimately lost the most money during the financial implosion. The researchers concluded that financial sector lobbying of this sort poses a threat to economic stability and increases systemic risk:

[The results] tend to support a theory of “moral hazard” whereby financial intermediaries lobby to obtain private benefits, making loans under less stringent terms not because they have better capacity to evaluate risks associated with the loans, but because they expect short term gains from these loans during the boom phase, and to be bailed out when losses amount during a financial crisis. These results…provide indirect evidence that lobbying might have the potential to threaten financial stability and contribute to systemic risk.

In those same years, financial firms increased their lobbying by 25 percent, while the average increase in other industries was 10 percent. Meanwhile, in the last two years, hedge funds have quadrupled the amount that they spend on lobbying (see graph at right).

So the moral of the story is that financial firms lobby to make the rules fit the tactics that they want to use, and lawmakers respond accordingly, instead of creating a system that forces firms to use more due diligence and employ more caution. This is worth knowing, since the Obama administration’s financial regulation plan likely won’t start moving until the fall, giving the financial industry lots of time to work its magic.