Banks and bailouts: Playing politics?

Dec 21, 2009

(PhysOrg.com) -- Banks with strong political connections were more likely to receive bailout money from the government—and more of it—in the past year than those with weaker ties, say University of Michigan researchers.

A new study by Ran Duchin and Denis Sosyura of Michigan's Ross School of Business found that banks with connections to members of congressional finance committees and banks whose executives served on Federal Reserve boards were more likely to receive funds from the Troubled Asset Relief Program, the federal government's program to purchase assets and equity from financial institutions to strengthen its financial sector.

Further, their research shows that TARP investment amounts were positively related to banks' political contributions and lobbying expenditures, and that, overall, the effect of political influence was strongest for poorly performing banks.

"Our results show that political connections play an important role in a firm's access to capital," said Sosyura, U-M assistant professor of finance. "The effects of political ties on federal capital investment are strongest for companies with weaker fundamentals, lower and poorer performance—which suggests that political ties shift capital allocation towards underperforming institutions."

In their study, Duchin and Sosyura focused on the Capital Purchase Program, the largest TARP initiative in terms of the number of participants and the amount of expended capital. As of late September, nearly 700 financial institutions had received about $205 billion under the program.

The researchers used four variables to measure political influence: 1) seats held by bank executives on the board of directors at any of the 12 Federal Reserve banks or their branches (the Federal Reserve is involved in the initial review of CPP applications from the majority of qualified banks); 2) banks with headquarters located in the district of a U.S. House member serving on the Congressional Committee on Financial Services or its subcommittees on Financial Institutions and Capital Markets (which played a major role in the development of TARP and its amendments); 3) banks' campaign contributions to congressional candidates; and 4) banks' lobbying expenditures.

They found that a board seat at a Federal Reserve Bank was associated with a 31 percent increase in the likelihood of receiving CPP funds, while a bank's connection to a House member on key finance committees was associated with a 26 percent increase, controlling for other bank characteristics such as size and various financial indicators.

"Our findings also suggest that qualified were more likely to receive an investment from CPP if they were bigger and had lower earnings and lower capital," said Duchin, U-M assistant professor of finance. "This is consistent with an investment strategy seeking to support systematically important institutions experiencing financial distress."

In addition, the study found the amount of CPP investments was strongly related to banks' political contributions and lobbying expenditures. A one standard-deviation increase in political contributions to congressional candidates was associated with a $14.6 million increase in allotted CPP funds, while a one standard-deviation increase in lobbying amounts was associated with an additional $10.4 million in CPP funds.

Duchin and Sosyura say the amount of CPP investments was negatively related to capital adequacy, earnings and liquidity, and positively related to bank size.

"Collectively, these findings are consistent with an investment strategy seeking to increase the capitalization and liquidity of participating banks to an adequate level, but also highlight the importance of political connections in the choice of federal investments," Sosyura said.

Explore further: Gifts that generate gratitude keep customers loyal

add to favorites email to friend print save as pdf

Related Stories

Corruption is Expensive, But Who Pays the Bills?

Mar 25, 2008

One often must look no further than today’s headlines to find examples of personal failure, corporate financial woes and political corruption. But how does political integrity affect the bottom line? A University of Missouri ...

Shocks and Stress Tests

Aug 21, 2007

In response to federal banking regulators' concern about community banks' increased participation in commercial real-estate lending, a University of Arkansas researcher has developed a system that allows banks to perform ...

Recommended for you

Study identifies upside to financial innovations

38 minutes ago

Financial innovations can make or break an economy. While the negative impact of financial innovation has been extensively covered, a new study of financial innovations before and during the last financial crisis indicates ...

Study shows social welfare may fall in a more ethical market

Aug 25, 2014

For "credence services" such as auto-repair, healthcare, and legal services, the benefit to the customers for the service is difficult to assess before and even after the service. A new study in a journal of the Institute ...

The tyranny of realism in energy planning

Aug 20, 2014

A report exploring the political economy of energy planning under democracy and the Integrated Energy Planning (IEP) process due to conclude this year was launched by the British High Commission, Project ...

User comments : 2

Adjust slider to filter visible comments by rank

Display comments: newest first

Truth
not rated yet Dec 21, 2009
And the cutting edge physics report in this article is......?????
marjon
not rated yet Dec 21, 2009
the study found the amount of CPP investments was strongly related to banks' political contributions and lobbying expenditures.

Government controls the money. What do you expect?