Wednesday, 11 January 2012

Crony capitalism and the financial crisis

I will start this post with a video from the Economic Freedom webpage...




...and a definition of the term cronyism taken from the same source:
"Cronyism occurs when an individual or organization colludes with government officials to get forced benefits they could not have otherwise obtained voluntarily. Those benefits come at the expense of consumers, taxpayers, and everyone working hard to compete in the marketplace."

My paper on the financial crisis published last year included a chapter on the rising political power and lobbying of the financial sector to explain their enormous accumulation of power and their interconnection with government officials.  

The summary of the paper is presented on the blog page, where the mentioned chapter has been left out. The causes of the subprime crisis, the housing boom and bust, its contagion on finance and the real sector and consequently onto the welfare states of Europe, are many. The cronyism of the capitalist system in the US and particularly in peripheral Europe contributed to such an enduring crisis and is preventing its swift recovery.

The chapter in the paper recognizes several factors that may provide proof for cronyism: regulatory oversights, increased financialization, lobbying expenditures, rising national support for the finance industry and even the ‘flow’ of individuals between Wall Street and Washington. On that particular point I would recommend an excellent book by Simon Johnson, “13 Bankers” which provided some new insights on the connection of Wall Street and the political establishment. He finds that it became “a tradition for Goldman Sachs employees (Paulson, Rubin) to find jobs in public services after they leave the firm, and vice versa”.

But what is even more obvious proof is the correlation between the amount of bailout funds each financial company received and its lobbying expenditures and campaign donations to politicians in committees who made these decisions. I prepared a figure depicting this relationship between lobbying expenditures in 2008 and the share of received bailout funds  in total assets (also in 2008 to avoid any biases):

Source: Vukovic (2011) “Political Economy of the US Financial Crisis 2007 – 2009Financial Theory and Practice, Vol. 35(1) 91-128

Even though correlation doesn’t imply causality, the figure does provide an interesting discussion point on why some companies received more and some received less.

(Note: a complete analysis would have to disclose information on the balance sheets of these institutions and the relative exposure to risks they possessed at the time for the economy as a whole. After knowing that information one can evaluate in more precision the role of lobbying and campaign donations in the total bailouts received. This paper doesn’t cover that, but I’m working on a new paper that will look at this interesting relationship more closely. I also plan to include all recipients of the bailout funds, not just the financial sector)

Here are some excerpts form the text:
"Banks such as Citigroup, JP Morgan Chase or Bank of America spent a lot of money on lobbying activities to avoid bankruptcy and acquire additional benefits for further business activities (such as acquisitions of Bear Sterns and Washington Mutual by JP Morgan Chase or Merrill Lynch by Bank of America). Their lobbying activities did not allow the Lehman Brothers scenario. Although they were also companies full of ‘toxic’ assets they ended up acquiring new banks and expanding their business activity."
 "...one that stands out is AIG which has in the last 10 years, as well as in 2008, spent the most money on lobbying. ... AIG was given two times more funds than any other financial company." "...bailout funds received by AIG ... were approximately 8% of AIG asset values. No other bank received bailout funds of more than 2.5% of its total assets."
 "Lehman Brothers, the only big bank that was left to fail did not invest as much into lobbying and political campaigns as other financial institutions that found themselves in similar problems." Vukovic (2011)
It’s best to see Table 4 in the paper for further clarification.

Another interesting company was Wells Fargo, with clear implications on buying political influence.
"Before the purchase of Wachovia Bank, the size of the Wells Fargo assets was approximately the same as that of Lehman Brothers. Nonetheless, Wells Fargo was given more than or the same amount of bailout money as much larger banks. However Wells Fargo’s clever investments in political campaigns during the crisis left them in an even better position than before" Vukovic (2011)
The data on campaign donations was taken from the Center for Responsive Politics and the individual web pages of congressmen that accepted these donations (including Nanci Pelosi, the House Speaker, and Carolyn Maloney, member of a series of committees regarding the financial sector). Adding to this the amounts, sizes and sources of donations given by Fanny and Freddie (a case made earlier in the paper) further paints the picture of the political-business interconnection and cronyism that happened before and during the financial crisis.

What is making taxpayers angry the most is the use of their money to help out these huge behemoths of power. However, their attacks on the capitalist system are misguided, as they aren’t mad at capitalism, they are mad at crony capitalism. One is based on competition and free enterprise, and the other is based on political favours and protectionism. One leads to growth and prosperity, and the other into depletion of resources, high inequality and misery. The choice is simple - we will unwittingly support cronyism or opt for a change in the system that will bring back the years of prosperity. As voters, we do have that power - that, after all, is the point of political economy. 

5 comments:

  1. awesome graph! I'm looking forward to the full analysis of the correlation.

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  2. Good work on the graph. One correction, Correlation does not PROVE causality, but in this case it most definitely implies it.

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  3. thanks! I know, that's why I wrote under the graph: "correlation doesn’t imply causality" :)
    But anyway, there's a whole bunch of other factors that can determine the bias of the estimator, like relative exposure to risk for example. That's why I am thinking of broadening this analysis to eliminate any possible biases and to determine whether there actually exists any causal relation..

    If you happen to have any helpful ideas, they're most welcomed

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