In yesterday’s blog, I discussed one of the more novel ways that the conservative lobby against government spending is mobilising to present their case. In that paper, it was argued that spending “funded” by taxation is always captive to political lobby groups who ensure the government will waste spending and undermine the productivity of the economy. Alternatively, the author claimed that government spending should be disciplined by financial markets who would reduce the waste that is inherent in public outlays. While there were several flaws in the argument the one that we deal with today focuses on the assumption that financial markets allocated resources optimally.
The paper said that projects “funded” by taxation “encourage individuals to lobby to be members of favored groups … Economies prosper, however, when governance institutions reward productive efforts, and suffer when individuals instead seek redistributive rents”.
So the answer proposed is to reduce spending and taxation overall (that is implied by the conservative agenda) and force whatever minimal spending is required to be “funded” by debt issuance because the financial markets “can give us a better idea of the appropriate scope of government activity and encourage a less wasteful employment of public resources once that scope is set”.
Note the “funded” is always in inverted comma when I report some mainstream mis-representation of the role of taxation. Modern monetary theory (MMT) leads to an understanding that taxes do not “fund” anything because the notion of “funding” is inapplicable to a sovereign government which issues its own currency. Such a government never needs to fund its spending.
This is true despite the institutional arrangements and supporting rhetoric that makes it look as though a sovereign government collects tax revenue, pops it into a bank and then subsequently spends it. The role of taxation is to reduce the private sector purchasing capacity to either give more real space to the public to conduct its socio-economic program without inducing inflation.
Anyway, apart from fundamentally misunderstanding the way the fiat currency system operates and confusing the roles of taxation and debt-issuance, the writer seems naive in the extreme about the relative lobbying behaviour of taxpayer groups and financial market interests. The implication is that the latter is an impersonal, market-driven approach where competition and arbitrage create optimal cost-minimised outcomes and the former is a viper’s nest of pork-barrelling and special interests.
The naivety of this position is highlighted by an IMF working paper that was released late in 2009. The paper – A Fistful of Dollars: Lobbying and the Financial Crisis – written by Deniz Igan, Prachi Mishra, and Thierry Tressel. The paper is somewhat technical with lots of regression analysis but is generally accessible.
The authors claim it 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”, which is probably correct.
They “identify lobbying activities on issues specifically related to rules and regulations of consumer protection in mortgage lending, underwriting standards, and securities laws”.
There were two types of legislation that were targetted. Money was spent to derail legislation that was promoting tighter restrictions on the financial markets. For example, “tight restrictions for lenders focus primarily on predatory lending practices and high-cost mortgages … many bills contain restrictions/limits on annual percentage rates for mortgages, negative amortization, pre-payment penalties, balloon payments, late fees, and/or the financing of mortgage points and fees. Expanded consumer disclosure requirements regarding high-cost mortgages (such as including the total cost of lender fees on loan settlement paperwork or disclosing to consumers that they are borrowing at a higher interest rate) are introduced in some of the bills.”
Some of the bills would have forced the banks to make more complete assessments of the consumers’ ability to repay the loans and that loans should not be in excess of 50 per cent of the reported income.
The study focuses on 33 federal bills in the US that would have reduced predatory lending and introduced more responsible banking. The Appendix provides many examples of this type of legislation that was targetted by the lobbyists. For example, the Predatory Lending Consumer Protection Act 2001; the Predatory Mortgage Lending Practices Reduction Act 2003; Responsible Lending Act 2005; Predatory Lending Consumer Protection Act of 2002 and others were never passed by the US House or Senate after the lobbying efforts.
They show that the lobbying efforts in this area of legislation was overwhelmingly successful.
Money was also spent to promote legislation that reduced restrictions on financial markets including “lower down-payment requirements; state and local grant funding to provide down-payment assistance for certain borrowers; hybrid adjustable rate mortgage programs; revised mortgage insurance premiums and cancellation policies; and financial assistance when purchasing homes in high-crime areas or low-income areas.”
There were also bills that relaced the the oversight on the large mortgage providers such as Fannie Mae and Freddie Mac. These large providers would originate the mortgages which would then be bought and packaged by the big investment banks and on-sold to other investors. You see bills like “American Dream Downpayment Act” passed which was the target of lobbying and made it easier for low-income families to gain a mortgage.
Again, the lobbying efforts in this area of legislation was very successful.
The following graph is reproduced from their Figure 1 which shows the “lobbying intensity (defined as lobbying expenditures per firm) by sector” in US dollars in 2006.
It is clear that firms in the FIRE industry (Financial, Insurance and Real Estate) spend more on lobbying that firms in other industries. “Firms lobbying in the FIRE industry spent approximately $479,500 per firm in 2006 compared to $300,273 per firm in defense or $200,187 per firm in construction”. The paper also shows that the “the lobbying intensity for FIRE increased at a much faster pace relative to the average lobbying intensity over 1999-2006.”
On page 65 (Table A2) you can see an actual copy of the Lobbying Report Filed by Bear Stearns where they paid $US500,000 to buy votes that would water down the The Mortgage Reform and Anti-Predatory Lending Act of 2007 in the area of “lending and securitization standards”.
On Page 67, you see that Bank of America paid $US1,020,000 to derail a number of financial market bills.
So what did they find?
It turns out that the US banks that spent the most on lobbying the US government to ease financial market regulation in their favour:
… (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.
That is, the firms who lobbied the most were mostly likely to be the firms that created the crisis.
After considering a number of possible explanations for the finding that “lobbying is associated ex-ante with more risk-taking and ex-post with worse performance” they conclude that the evidence is consistent with the view 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.
The conclusion supports the claim that major financial institutions were successful in undermining regulation that would have made it harder for them to engage in the more risky and predatory antics.
It also is clear that the Wall Street lobbyists funded votes that made it easier for them to escalate the housing boom in the US driven by the sub-prime market.
It is clear that from any perspective this lobbying led to a “misallocation of resources” which means that financial markets are not good judges of the best use of a society’s resources nor provide effective discipline to ensure the socially optimal configuration of private (and public) spending is achieved.
Anytime you hear some economist say that private markets allocate resources better than the government you should just laugh. There is overwhelming evidence that the proposition is simply untrue. All allocations require regulatory forebearance and transparency in decision making.
In the case of financial markets we could reduce these unproductive activities by outlawing most of the activities in that sector and only allowing those aspects that advance public purpose (that is, increase real welfare standards) and maintain financial stability. The clock has to start ticking on this industry. There should be as large a mobilisation by citizens against the influence of this industry as there is about climate change. Both issues are central to our future.
The UK Guardian carried a column about the IMF report (January 4, 2009) and quoted a fraud investigator who helped uncover the Bank of Credit and Commerce International (BCCI) scandal in the 1990s. He said:
In my entire career investigating financial fraud, fraud was always explained away as perpetrated by a few bad apples. This is plainly untrue. There has been a systematic refusal to look hard at how this has happened. I’m delighted the IMF are using mathematical formula to look at something that has been obvious to so many for so long. There’s nothing new and surprisinmg about this. The question is where was the IMF when this happened?
When you evaluate what sort of regulations have been introduced to date – some 24 months into the crisis – you will have to search hard for tighter mortgage controls of the sort that were contained in the US government bills that were successfully derailed by the Wall Street lobbying efforts.
There is also clear evidence that US banks pocketted billions in federal government bailouts (under the TARP) yet continued to heavily lobby legislators who were considering increasing financial market regulation (Source)
Further, in Australia even the central bank gets involved with shady political lobbyists. On August 4, 2009 there was a report in the Melbourne Age entitled – Cash for contract claims which said that:
A Reserve Bank of Australia subsidiary allegedly paid a six-figure sum to an Indian political lobbyist as part of a campaign to break into the world’s biggest banknote market.
A complainant with intimate knowledge of the operations of polymer banknote maker Securency has told Australian Federal Police that a senior company executive allegedly disclosed to him in 2007 that a $120,000 donation was made to Indian political figures.
This was not the first allegation made against this company which is half-owned by the Reserve Bank. It seems that they have been bribing foreign officials in a number of countries to to win banknote supply contracts.
The same authors reported in November that:
Securency’s senior managers shredded documents and hid files to stop RBA auditors learning the full details of its arrangements with foreign middlemen.
The RBA wanted to examine Securency’s agent arrangements in 2006-07, but well-placed sources claim Securency’s management stymied RBA auditors to the extent they could not conduct a proper examination.
The company was allowed to continue using its vast network of foreign middlemen and it continued to send millions of dollars into offshore tax haven accounts.
You might wonder what this is all about. Well the RBA developed and introduced the first polymer banknote 22 years ago which was a world first in high technology currency development.
The motivation came in the late 1960s when there was a major counterfeit $10 bill scandal just after the new decimal currency was issued. As an aside, I went to school with a person related to one of the counterfeiters.
Securency was formed as a 50-50 joint venture in 1996 between the RBA and Innovia Films, which had had produced the polymer material. The original joint venture was between the RBA and Belgian polymer manufacture UCB who later sold its interest to Innovia.
At the time, public-private partnerships were becoming the flavour of the decade. The neo-liberal distaste for public sector activities forced a number of enterprises to be privatised and/or forced into PPPs. The RBA should never have got involved with a private firm in this context.
It could have simply purchased the polymer and exploited the opportunities itself. But the rhetoric was always that the “market” knows best and public companies are inefficient and wasteful.
The recent financial crisis has certainly knocked a few of those claims “out of the ground”. (cricket term).
Propaganda machine steps up a notch
Just before Xmas there was a press release announcing that:
The Fiscal Times, a new independent digital news publication devoted to quality reporting on vital fiscal, budgetary, health care and international economic issues will launch in early 2010 … The news operation will begin publishing with a roster of experienced journalists and leading opinion contributors, whose reporting and insights will aim to drive the conversation surrounding our nation’s most pressing economic issues.
Further, the Washington Post which in its glory days undid the corrupt US President Nixon has entered a partnership with the Fiscal Times to “jointly produce content focusing on budget and fiscal issues that will be available to both publications.”
The Fiscal Times is being funded by Peter G. Peterson, the right-wing Wall Street billionaire who pumps out material and buys exposure for his ravings about the fiscal crisis and the impending disaster as the US Social Security system goes broke.
The first joint venture article – a propaganda piece against US social security spending was published in the Washington Post on December 31, 2009. Shameful.
Cartoon source: The cartoon was drawn by David Horsey and was published on Thursday, October 29, 2009.