According to researchers, well-connected bankers have benefitted from trading their shares before receiving government money.
When you dig into Wall Street data during the worst months of the global financial crisis, a strange pattern emerges: several hundred bankers with political connections were bullish about their prospects while it seemed everyone else wasn’t. The group purchased shares in their banks before announcing additional bailout funds and reaping personal benefits. This is according to a research paper by four university academics.
Researchers studied the trading behaviors of bankers during the financial crisis. They wanted to know if they had predicted the crash or if their trading patterns changed during the recovery.
The study found that bankers with political connections bought and sold their banks’ stocks in the days before a new government bailout infusion, thereby boosting their stock portfolios.
The study’s co-author, Stanford Graduate School of Business professor David Larker, says that the findings show that insiders gained an advantage from political connections during the financial crisis. A significant part of this advantage was due to their knowledge of government intervention.
Piqued Interest
The team of researchers — Larcker and Alan Jagolinzeropen new window to the University of Colorado, Gaizka ormazabalopen new window to the University of Navarra, and Daniel Tayloropen new window to the University of Pennsylvania — was at Stanford during the financial crisis and was intrigued by a trading behavior in the unprecedented period of market change.
Investors faced a challenging first half of 2008. As the year progressed, the S&P 500 steadily lost ground amid housing market concerns. Bear Stearns, an investment bank, collapsed in March. Lehman Brothers filed for bankruptcy in September, the U.S.’s fourth-largest investment bank. By mid-October, the S&P had dropped by 24 %.
Then-Treasury Secretary Henry Paulson worried that the banking sector might fail, rushed through Congress the Troubled Assets Relief Program, which allowed the federal government to invest hundreds of billions in boosting bank liquidity.
Late in October 2008, the government made the first TARP injection, injecting $115 billion into the country’s nine largest banks. The first round of TARP was mandatory. Subsequent games were optional. The program was applied for by hundreds of banks throughout the nation. Treasury decided who received funding. Seven hundred-five financial institutions were awarded $205 billion. The list was kept secret until the official announcement.
Larcker remembered conversations with his Stanford colleagues as the bailout proceeded. The group wanted to know: Was there evidence that bankers had sold shares in anticipation of the crisis?
Larcker was sceptical. Larcker was skeptical.
The data showed the opposite. It appeared that trading volumes among bank executives increased not before but during the financial crisis in the days preceding the new infusions.
Larcker, along with his co-authors of the study, were fascinated. Why did some banks make trades anticipating TARP money, but others did not?