The best democracy money can buy?

Ahmed Tahoun asks whether American lawmakers use their power to protect their own interests


Members of the United States Congress should know where they stand. The code of conduct that binds members of both the Senate and House of Representatives stresses that they must not let their personal interests compromise their duties as lawmakers. Their concern for their personal finances should not sway their choices when taking decisions on behalf of the voters who elected them.

It is an undoubtedly commendable principle. But how effective is it in practice? Do members of Congress succeed in putting their own financial interests aside when deciding what is best for their country?

Laurence van Lent of the Frankfurt School of Finance and Management and I looked at how members of Congress voted when they were asked to consider the bailout of the financial sector when crisis engulfed the global banking system in autumn 2008. In essence, we asked a simple question: was there any correlation between individual politicians’ support for the bailout and their stake in the financial institutions they were being asked to rescue?

The collapse of Lehman Brothers triggered a crisis: there was a real risk that the global financial system would seize up. Hank Paulson, then US Treasury Secretary, and Ben Bernanke, who was chairing the Federal Reserve, were fully aware of the danger. They approached Congress and sought backing for a comprehensive bank bailout.

Paulson initially outlined a scheme under which banks’ toxic assets would be bought by the government. The idea was controversial: George W Bush was still in the White House and bailing out failing companies – any failing companies – went completely against the grain of the Republicans’ free market rhetoric.

Paulson’s plan was rejected. But as the full extent of the threat to the global banking system and economy became increasingly evident, a new scheme was devised: it cleared the way for government money to be used to recapitalise banks.

Polls showed that the public didn’t like the idea of using $700 billion of taxpayers’ money to bail out Wall Street. Given the size of the sum, that was hardly surprising: it was equivalent to more than $2000 for every man, woman and child in the country.

Nevertheless, on October 1st 2008, the Senate approved the Emergency Economic Stabilisation Act. Two days later, the House of Representatives gave its blessing and the legislation was signed into law by President Bush. The banks were saved.

Politicians’ votes on the bill that led to the Act were clear and public: it was easy to see who supported the legislation and who didn’t.

Less obvious and less publicised was the extent to which the lawmakers had a personal financial interest in making sure that banks survived. But we were able to glean that information from the details of personal finances – assets, investments, borrowings – that Senators and members of the House are obliged to disclose.

So putting together these two sets of data – voting records and financial interests – what did we find? The result was striking: politicians whose investment portfolios were exposed to the financial institutions they were being asked to bail out were 60 percent more likely to vote for the act than those whose wealth was relatively immune to the effects of the crisis.

Around 30 percent of the members of the House of Representatives held shares in banks and other financial institutions: they were substantially more likely to back the bailout than other members of the House.

Overall, a politician with investments in finance were 60 percent more likely to vote for the bailout than someone without such investments.

But was this pattern simply because those with a personal stake in the banks didn’t want their own finances to suffer? Could there be other explanations?

Perhaps, for example, a politician’s willingness to support the bailout was a reflection of his or her ideological belief in the importance of financial institutions in a capitalist economy: such “finance-friendly” politicians would be inclined to support a rescue whether or not they held shares in banks.

We looked at the lawmakers’ backgrounds. Had they previously worked in finance or been members of finance-related congressional committees? If so, that could suggest that these people were “finance-friendly”. Our research showed that such experience did not per se significantly increase the likelihood of voting for the act.

Members of Congress were significantly more likely to invest in companies that gave them election campaigns funds

And what about politicians who had previously held investments in the financial sector but had sold out before the crisis struck? The fact that they had held such investments in the past suggested a general support for finance: we could reasonably infer that these “ex-investors” had much the same attitude towards banks as investors who still held financial sector shares at the time of the crisis. But again, this indication of “finance-friendliness” was no predictor of voting behaviour when it came to the crunch on the bailout vote. The key variable in determining whether a lawmaker was more or less likely to vote for the bank rescue was whether they held financial sector investments at the time of the crisis rather than in the past.

Taken together, the evidence underpinned our hypothesis that a vote for or against the bank bailout was likely to be affected by whether or not politicians held investments in the finance industry rather than their fundamental political beliefs.

It is certainly true that efforts have been made to stop politicians from making personal gains from non-public information gleaned in the course of their job as lawmakers: that is the aim of the Stop Trading on Congressional Knowledge Act. But that does not cover the circumstances we looked at. The act does nothing to stop lawmakers from passing legislation that benefits them financially.

Shouldn’t such behaviour be governed by the existing ethics rules? Certainly, that wasn’t the case when the financial crisis hit. The ethics rules were – and remain – very loose. At the time of the bailout, the rules implied that simply holding shares in companies did not in itself risk creating a conflict of interest.

Our research detailing the links between investments in financial institutions and the propensity to rescue those institutions highlights that the voting of politicians is associated with their financial stake in firms. However, the share ownership of members of Congress is important for another, perhaps more subtle reason. In a recent study I show that members of Congress were significantly more likely to invest in companies that gave them election campaigns funds compared with non-contributing companies. Put simply, there was a positive correlation between campaign contributions and investment in the company making those contributions.

Furthermore, that contribution-investment link was stronger the more powerful the position of the politician. If someone was on a powerful Congressional committee –or had seats on several powerful committees or was considered a senior member by virtue of having been in Congress for some time – then the contribution-investment correlation was likely to be more pronounced. Thus, one possible conclusion might be that politicians use their share in companies to forge mutually beneficial support relations. This idea finds further support in some empirical regularities I was able to reveal in my study:

Firms with a stronger contribution-investment association received more government contracts. The financial gains from these contracts were economically large. When politicians divested their stocks, firms discontinued contributions to the politicians, lost future contracts, and performed poorly.

Where a politician was put under investigation for a suspected breach of the ethics rules, then there was a distinct effect: after the investigation, he or she was less likely to invest in a firm contributing to their political campaigns than was the case before.

And politicians coming up for retirement were more likely to shed investments in companies making campaign contributions than in companies that were not. The politicians no longer needed the contributions of these firms. A second possible explanation was that once retired, the politicians would have less leverage in helping the businesses that have been contributors to their political campaigns.

But back to politicians and banks. Florin Vasvari, Professor of Accounting at London Business School, and I looked at the pattern of borrowings by members of the Senate. Don’t think that politicians don’t need to borrow because they are rich. Personal debt is substantial: liabilities are equivalent to almost 40 percent of the overall net worth of the average US congressional member.

The central question was this: did being a member of the finance committee of the Congress make it more likely that these lawmakers would take loans from the financial institutions they were scrutinising?

The answer was yes. When measured against their net worth, these finance committee members had higher borrowings than non-members. And even more strikingly, lawmakers joining one of the finance committees were likely to take on significant new liabilities after taking up committee membership. Politicians joining one of the finance committees were likely to take on new liabilities equivalent to more than 30 percent of their net worth within a year of their appointment.

Also, finance committee membership appeared to confer a benefit when a lawmaker took out a loan: interest rates were lower and loans were over a longer period than for non-committee members’ borrowings.

And looking at banks lending to Congress members, we found that it was the weaker-performing financial institutions that provided a disproportionate share of new loans.

Our conclusion: it appears that lenders may create political connections with finance committee members in an attempt to gain regulatory benefits.

So taken together, what do these various pieces of research tell us? And what questions do they raise?

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