Most Americans have become cynical about the cozy ties between business and government—a recent poll found that a sizable majority believes that government contracts are awarded primarily on the basis of connections rather than merit. We reserve particular disdain for the country’s bankers, and it’s easy to see why, after Wall Street executives walked away more or less unscathed from the financial crisis thanks to a government rescue. That rescue left many Americans wondering whether the bailout was designed to save the economy or just line the pockets of well-connected bankers.
The question of whether well-connected banks got special treatment during the financial crisis is the focus of a study, which has been in limited circulation in academic circles in recent weeks, by a group of authors that includes the eminent MIT economists Daron Acemoglu and Simon Johnson, along with Amir Kermani, James Kwok, and Todd Mitton. (Johnson and Kwok are longtime and vocal critics of the finance industry.) It won’t shock an already jaded public to learn that having friends in high places seems to have helped a lot: The paper shows that when Tim Geithner’s appointment as Treasury secretary was announced in November 2008, investors bid up the prices of banks run by Geithner’s friends and associates by as much as 10 percent (relative to the stocks of other banks) in expectation that they stood to gain from a Geithner-run Treasury.
But the study’s explanation of those stock price jumps is subtler than you might be expecting, as is the picture painted by recent research on ties between American business and government. We’re not talking about corruption of the Jack Abramoff–Rod Blagojevich variety. Rather, government leaders needed to get information from people they trusted in the private sector, which in turn created opportunities for those trusted sources to exploit their privileged access. As unsatisfying as it may seem, this is less a story about outright villainy than about human nature and the rushed decision-making required in a time of crisis.
Before addressing the question of how political connections might deliver value to executives and their companies, it’s worth assessing whether such ties deliver higher profits in the first place. Researchers have often turned to the stock market to answer this question. News that makes investors more optimistic about future profits—like a biotech firm announcing a cure for cancer—will make the company’s stock go up. Likewise, bad news will drive share prices downward. If investors believe political connections are valuable, the waxing and waning of the careers of politicians should induce similar ups and downs in the share prices of companies they’re connected to. Why should investors’ beliefs reflect the realities of a company’s future profits? While stock market investors can certainly be wrong (as they were when they bid up financial stocks in the first place, only to see them crash in 2008), there’s a lot of money riding on these decisions. The investors who move equity markets have every incentive to put in the time and resources to make the best-informed decisions possible.
This “political event study” method was pioneered by political scientist Brian Roberts in a 1990 study on the market’s reaction to the news of Sen. Henry “Scoop” Jackson’s sudden death in 1983 from a heart attack. Jackson, a Democrat from Washington state, was serving at the time as chair of the Senate Armed Services Committee, and his death was bad news for local companies like Rockwell International, whose profits were reliant in part on military contracts. News of his death led to a 2.5 percent drop in the share prices of Washington-based companies that made campaign contributions to Jackson. But one tricky part of using the stock market to understand what’s good or bad for companies is that the market-moving news has to be unanticipated. You can’t, for example, expect to learn much about what a second Clinton term would mean for corporate America by looking at stock returns on Election Day: Since Clinton was a heavy favorite, investors had already placed their bets on companies under the assumption that he’d win another term.
The just-released study exploits a news leak on Nov. 21, 2008—amid the deepest turmoil of the financial crisis—that Geithner would get the nomination as Treasury secretary. (Geithner had been on the short list for the job, along with Larry Summers, Jon Corzine, Paul Volcker, and Sheila Bair. The news leak effectively narrowed the field from five credible candidates to one overnight.) Who might have been expected to benefit from the nomination? The study’s authors develop two measures of connectedness to Geithner, based on his appointment book and his social activity in the years leading up to his nomination. Since Geithner’s meetings as New York Federal Reserve president were a matter of public record, the researchers were able to count the number of times executives from various banks met with him during 2007–2008. It’s not surprising that Geithner met often with leaders from big banks—a total of 34 times with Citi execs and 12 times with J.P. Morgan bankers. But among smaller financial institutions there are some banks that also found time on Geithner’s calendar—Lazard and Astoria Financial, for example—while others didn’t, like E-Trade or State Street.
Of course, banking execs might have been meeting with Geithner because they were experiencing financial difficulties or being closely monitored for other reasons—in other words, not reasons likely to have resulted in strong ties. So the study also uses a measure based on Geithner’s personal ties listed on Muckety, a website that maps the connections among America’s rich, famous, and influential. The authors supplement Muckety’s list by examining the nonprofit boards that Geithner sat on to see where his board affiliations overlapped with those of banking executives. (It’s a sure bet that investment analysts were poring over these and other sources back in 2008 to figure out who to bet on when news of the Treasury appointment broke.)
How much was it worth to chat with Geithner at, say, a board meeting of the National Academy Foundation, as American Express CEO and fellow Academy board member Kenneth Chenault might have in 2008? According to the study, stock prices of companies whose executives had personal ties to Geithner went up by around 10 percent relative to comparable banks that lacked such connections. They also estimate a benefit—albeit a smaller one—for banks who show up frequently in Geithner’s New York Fed appointment calendar. (The study shows that the share prices of New York–headquartered banks in general made out better as the market reacted to the Geithner announcement. The authors argue that this indicates a benefit of connections based on geographic proximity.)
Were investors’ expectations borne out? Did Geithner-connected firms actually benefit from a Geithner-run Treasury? It’s hard to say for sure. One of the virtues of looking at stock market responses is they allow researchers to see how investors respond to a specific piece of news. But over the longer run, the effect of any particular news item (like Geithner’s appointment) is usually washed out by the noisy ups and downs of equity markets, making it hard to look at what happened to companies’ prices over Geithner’s tenure at Treasury. Connected companies were, for example, more likely to renegotiate the terms of their “stress test” with the government, and big banks—all of them Geithner-connected—also did well by the government’s bailout of insurance giant AIG. But it’s hard to say exactly what would have happened in Geithner’s absence, and the authors shy away from accusing the secretary of any particular cases of favoritism.
Still, investors were willing to bet that well-connected banks would benefit under Geithner’s tenure, as evidenced by the bidding up of those banks’ stocks. This is somewhat surprising given that Geithner doesn’t fit any of the standard storylines around the value of connections. No one—not even his harshest critics—has ever accused Geithner of taking bribes or any other variant of trading money for influence. Nor was it plausible, the authors argue, that Geithner would help his friends in exchange for lucrative positions down the road: As outgoing New York Fed president, he could easily have walked straight into a seven- or eight-figure Wall Street salary without a low-paid stint in Washington. Nor was Geithner beholden to donors as many elected politicians are—both Fed president and Treasury secretary are appointed positions. And unlike a senator or congressman, he wasn’t beholden to the interests of his home state.
The authors argue that the enormous value that investors conferred on connections may have been somewhat unique to the panicked circumstances in Washington when Geithner’s appointment was announced. It was an unusual time to be Treasury secretary. Hundreds of billions in bailout funds were to be spent; Geithner and his team had considerable leeway in how cheap capital was to be distributed to financial institutions and how troubled assets would be removed from banks’ balance sheets. A senior administration official described the benefits of one Geithner-era program as having been “designed by Wall Street, for Wall Street.” And who, presumably, would Geithner turn to for advice on how to implement such programs? Those he trusted, knew, and perhaps had conferred with in the past. Key Geithner hires were in fact drawn from the ranks of connected firms like Goldman Sachs, Blackstone, Lehman-Barclays, and Citi, and a look at Geithner’s publicly accessible calendar while at Treasury indicates that he met with a number of his friends from banking immediately prior to the passage of the Dodd-Frank Act, a package of financial reforms.
In the end, what the study points out, more than any kind of nefarious cronyism, is the uneasy relationship between the government’s need for well-informed advisers in order to develop good policies and the extent to which those advisers might exploit their connections for financial gain. In most instances, there may be sufficient checks and balances in place, as well as sufficient scrutiny from the media and watchdog groups, to ensure that policymakers don’t play favorites. But desperate times call for desperate—and quickly implemented—measures, which may afford more opportunities for policymaker discretion and fewer opportunities for oversight. That is the argument implied by the study’s title: “The Value of Political Connections During Turbulent Times.” (As Kermani, one of the study’s authors, pointed out to me by email, there’s further anecdotal support for this view in the awarding of a massive no-bid contract to Halliburton—a company formerly run by Vice President Dick Cheney—during the chaotic Iraq War years. Back in the more tranquil era when George W. Bush surprised the American electorate by picking Cheney as his vice presidential candidate, the markets didn’t change their valuations of Cheney-connected companies.) Investors, at least, were willing to bet that the circumstances would redound to the benefit of well-connected banks.
The new study also points to the challenges of reforming the way that businesses interact with the U.S. government. While we’re nowhere close to a Putin-style kleptocracy, there’s ample evidence that connections in Washington get you greater access. But if we outlawed anyone with connections to special interests serving in office, who would be left to govern the country? If we completely did away with the lobbying industry, what channels would allow well-informed parties (albeit with vested interests) to make their case to lawmakers? None of this is to suggest that we are governed by the best of all possible political systems—look no further than the recent government shutdown for evidence to the contrary. But there are trade-offs in the messy realities of designing democratic institutions. Maybe the best we can hope for is some variant on the current system, which includes the participation of investigative journalists, activists, and researchers calling attention to situations where there’s reason to wonder whether officials’ interests are aligned with those of the people they’re meant to serve.
Ray Fisman is the co-director of the Social Enterprise Program and senior scholar at the Chazen Institute at the Columbia Business School. He is the co-author, with Tim Sullivan, of The Org: The Underlying Logic of the Office. Follow him on Twitter.