Thursday, December 31, 2009

IMF: Mortgage Lenders That Lobby Washington Do Riskier Lending and Have Higher Delinquencies

An International Monetary Fund study finds a significant correlation between lobbying by mortgage lenders in the United States and the prevalence of riskier loans and higher delinquencies in markets where lobbying lenders increased their level of lending faster than non-lobbying lenders.

By Robert Stowe England
MindOverMarket.blogspot.com

December 31, 2009

The International Monetary Fund (IMF) has released a working paper that examines the relationship between lobbying by mortgage lenders and the performance of loans in markets where lobbying lenders originated mortgages.

The working paper is titled “A Fistful of Dollars: Lobbying and the Financial Crisis” and authored by economists Deniz Igan, Prachi Mishra, and Thierry Tressel.

It is posted at this link: http://www.imf.org/external/pubs/ft/wp/2009/wp09287.pdf

The study analyzes detailed information on lobbying and mortgage lending activities.

For loan data, the study relies on data complied under the Home Mortgage Disclosure Act (HMDA) of 1975. This data is collected by the Federal Reserve Board from 9,000 lenders in 378 Metropolitan Statistical Areas (MSAs).

The IMF study found that “lenders lobbying more on issues related to mortgage lending had higher loan-to-income ratios, securitized more intensively, and had faster growing portfolios,” the report states.

More specifically, the study finds, “delinquency rates are higher in areas where lobbyist lending grew faster.”

The study states:

The estimated effect is economically significant: a one standard deviation increase in the relative growth of mortgage loans of lobbying lenders is associated with almost a 1 percentage point increase in the delinquency rate.

The study also finds that lobbyist lenders “experienced abnormal stock returns during key crisis events” – namely, the lobbyist lenders had sharp declines in stock values during the crisis events of 2007 and 2008.

The loan-to-value measure was seen by the IMF authors as a proxy for lending standards. The recourse to securitization and the rate of growth in lending were also seen as potential measures of risky lending.

Data Analysis

The authors also looked at possible explanations for the link between lobbying and risky lending.
“Our findings indicate that lobbying is associated ex-ante with more risk-taking and ex-post with worse [loan] performance,” the authors conclude.

“This is consistent with several explanations, including a moral hazard interpretation whereby lenders take up risky lending strategies because they engage in specialized rent-seeking and expect preferential treatment associated with lobbying,” the study reports.

“Such preferential treatment could be a higher probability of being bailed out, potentially under less stringent conditions, in the event of a financial crisis,” the authors state.

“Another source of moral hazard could be ‘short-termism,’ whereby lenders lobby to create a regulatory environment that allows them to exploit short-germ gains.”

The authors also explore other explanations for the poorer loan performance of loans originated by lobbying lenders. One is that the lenders “may specialize in catering to borrowers with lower income levels and originate mortgage that appear riskier ex ante, with a higher incidence of default in a downturn.”

The authors also consider one possibility that lobbying lenders may be “over-optimistic” about their prospects and “may lobby more intensively against a tightening of lending laws to exploit expected profit opportunities because they underestimate the likelihood of adverse events.”

While reasons not related to moral hazard “cannot be definitely ruled out,” the authors say that additional tests of the data suggest they alternative explanations “may be less likely to be valid.”
The results of the study “provide suggestive evidence that the political influence of the financial industry might have the potential to have an impact on financial stability,” the authors state.

Even so, the authors caution that “it is hard to distinguish whether it is rent-seeking or information-revealing that drives lobbying by the financial industry.”

Copyright © 2009 by Robert Stowe England. All Rights Reserved.

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