A recent update to a continuing study finds a link between bailouts and the lobbying of the financial industry.
It is sometimes asserted that the housing boom of the first half of the last decade was largely a result of easy credit by the Federal Reserve – that low interest rates made it too easy for too many people to borrow to purchase a new, bigger home.
But interest rates were only a bit lower in the decade than they were in the 1990s, when there was not a housing boom. By the standards of the 1990s, one might expect the somewhat lower interest rates of the last decade to elevate housing prices only a bit (as I have estimated; Edward Glaeser of Harvard and his co-authors have, as well), rather than the much sharper increase that actually occurred.
It’s also true that bank lending standards were relaxed during the housing boom, with risky borrowers allowed to purchase homes, and all kinds of borrowers allowed to purchase homes with little money down. But as Professor Glaeser has frequently noted, for instance in this post, the housing boom is not primary explained by easy credit.
Even if interest rates and lending standards had been the same in the last decade as they were in the 1990s, however, a crisis might still have been brewing, because interest rates should have been higher during the housing boom than they were before.
Housing prices were elevated during the boom (in part for the reasons cited above) and, by comparison with the 1990s, this made it more likely that — if and when housing prices came back down — even high-income borrowers making 20 percent down payments would default. With default more likely, interest rates needed to be higher, even for high-income borrowers putting 20 percent down.
The study, by Deniz Igan, Prachi Mishra, Thierry Tressel, three economists at the International Monetary Fund, suggests that implicit subsidies and a lack of regulation helped make it possible for lenders to offer lower rates on mortgages that were increasingly likely to default. My fellow Economix blogger Simon Johnson has also noted the interplay of political influence on regulation and finance.
The study by the I.M.F. economists found that the heaviest lobbying came from lenders making riskier loans and expanding their mortgage business most rapidly during the housing boom. The loans originated by those lenders were, by 2008, more likely to be delinquent.
Most important, lobbying meant access to tax dollars. The lenders lobbying more heavily were 7 percent more likely to receive bailout funds, received larger amounts of those funds, and enjoyed a 27 percent greater increase in their market capitalization in October 2008, the month the bailout program was announced.
The authors did not disentangle the path by which lobbying brought forth bailout funds, but it is likely to have followed some combination of political access enjoyed at the time and the lobbying lenders’ assertions of need — created by the lax lending that had gone before, itself facilitated by lobbying during the housing boom years.
Nobody knows for sure how much of the blame for the housing boom can be put on the federal government, but we’re starting to see how political influence was associated with mortgage lending and, ultimately, with taxpayer subsidization of delinquent and defaulting mortgages.