People’s Will or Wall Street’s Will?

2.25 million foreclosures were filed last year and at least 1.7 million are expected this year. This dramatic housing crisis is at the origin of the current financial and economic woes our country is experiencing. But if you were to look at Washington, you would hardly notice. Last February, Senator Dick Durbin (D-Ill.) introduced a proposal to redesign Chapter 13 in an attempt to help homeowners avoid foreclosure. In the past year his proposal was largely ignored. In the meantime, Congress approved a $168 billion tax cut for the first stimulus package, $700 billion to help banks, and even held an emergency session after the election to help General Motors and Chrysler. Compare it to HOPE, the limited program for homeowners approved only in October with nominal success to date.

The change in administration does not seem to have altered the focus: $825 billion for the new stimulus package and a new plan to commit between $1 – 2 trillion to create an “aggregator bank” that will relieve banks of their toxic assets at taxpayers’ expenses. And what about the homeowners? At most, they’ll get $50 billion of the TARP leftovers. Why so much interest in helping Wall Street and so little interest in helping Main Street?

This is certainly not a reflection of the will of the American people. In a recent representative survey of 1,038 Americans we find that 62 percent of respondents think that the government should intervene to help homeowners who are defaulting. By contrast, 48 percent approve the government helping banks, and only 41 percent approve of the government helping GM. Even the self-declared republicans, who vehemently oppose the bailout of GM (74 percent), are less averse to help homeowners (64 percent). Among democrats, the percentage in favor of helping homeowners is overwhelming (80 percent), as it also is among independents (59 percent). So why do two completely opposite administrations follow the same path?

One possibility is that the government knows what is best for the economic recovery of the country. Banks – the argument goes – are essential to the functioning of the economy. Saving banks will allow them to continue lending, which will sustain the economy.

This is certainly true, but restructuring mortgages and avoiding unnecessary and inefficient defaults will also help everybody. It will help the families who would otherwise lose their houses. It will help their neighbors who will not see the value of their homes depressed by a wave of foreclosures. It will help the economy, by supporting the consumption of all these families. It will also help banks, whose assets are directly and indirectly linked to the value of these mortgages. Hasn’t the banking crisis started precisely from this sector? So why so little attention?

Another, more cynical explanation is that elected officials do not respond only to the will of the people, but also to political contributions. Is it just an accident that in 2008 the financial industry spent $442.5 million in political contributions, while the automotive industry only spent $17.3, and homeowners spent none?

Unfortunately, this cynical explanation finds support in a recent paper by three of our colleagues.1 They find that, controlling for ideology, the higher the amount of political contributions congressman receive from the financial industry, the more likely they are to vote for TARP. And it is not simply that congressmen better pre-disposed toward the financial industry receive more money. In fact, political contributions do not seem to affect the vote of the 24 congressmen who are retiring in 2008.

This bias is no secret to the American people. In our survey, 50 percent of respondents believe that former Secretary Treasury Henry Paulson was acting in the interest of Goldman Sachs, and not in that of the country. The result is a loss in the trust Americans have toward their government, their institutions, and the financial markets.

President Obama, who has campaigned against special interests and in favor of a real change, should now be true to his promises and free us from the Wall Street tyranny. Given the economic disaster that has resulted from Wall Street lobbying, he should start with a temporary ban on banks’ lobbying. Banks are using our money to lobby against our interest. Second, he should drop the idea, so dear to Wall Street, of an aggregator bank and force banks’ investors to bear the losses they created rather than shifting them to taxpayers. Last but not least, he should make helping homeowners his top priority. Obama can do it, unless Wall Street has captured him too.

1Mian, Atif R., Sufi, Amir and Trebbi, Francesco, “The Political Economy of the U.S. Mortgage Default Crisis”. Chicago GSB Research Paper No. 08-17.

Paola Sapienza, Kellogg School of Management at Northwestern University, and Luigi Zingales, University of Chicago Booth School of Business

6 Responses to "People’s Will or Wall Street’s Will?"

  1. Anonymous   February 12, 2009 at 3:15 pm

    Investors include pension funds. If you’re going to write populist drivel, you should devote more attention to making it believable.

    • Guest   February 21, 2009 at 1:17 am

      You are a jackass.

  2. MLK   February 12, 2009 at 4:01 pm

    A young President surely aspires to have an eight year term and will definitely makes populist political decisions in favor of Wall Street. For example, the President’s cry on Executive pay cap (with a lot of loop holes) on companies that took TARP funds has been an eye wash to mislead the general American public opinion. I am wondering how long the American patience will last with the continued cronyism to Wall Street by policy makers.

  3. Anonymous   February 13, 2009 at 1:02 am

    I’ve yanked my funds from Wall Street. It’s a corrupt,rigged system. Anyway, personal experience and history point to decade or two of abysmal returns.These days I’m into hard assets,gold,guns…and lots & lots of bullets!

  4. Joop Teernstra   February 13, 2009 at 11:30 pm

    To those with the stacks of gold and ammunition:Isn’t it preferable to take a positive role to direct the future after the social Armageddon that you foresee? Say: sacks of selected fertile seed.Better than just thinking of shooting at people that will want to try to take your gold?Be sure to secure your stack of survival novels to be read in the light of your kerosene lamp.

  5. Guest   February 23, 2009 at 2:21 am

    Making the banks pay for their losses – that should be the one and only rallying cry.Its not communism or socialism or anything like that – its pure capitalism.”You can take the profits but must also take the losses”. Billions gone? Fortunes vanished? Let it all go. It is just paper and numbers anyway. Protect the small investor, let the others blow in the wind.They’ll soon be back on the saddle, but at least we’ll be happy to know there’s a few bruises this time.