Political bargaining and multinational bank bailouts

Abstract

This article examines the role of political bargaining and state institutions in explaining variation in state support to multinational banks (MNBs). International business theory predicts that multinational enterprises will engage in political activities to gain a competitive advantage over rivals. I hypothesize that MNBs with greater bargaining power and favorable institutions received state capital injections on more attractive terms than foreign rivals. I test this hypothesis by studying the October 2008 state recapitalizations of MNBs by the UK, France, Germany, the United States, and Switzerland. I measure the relative attractiveness of state bailouts by comparing the bank stock price reactions when the bailouts were announced. The stock prices of MNBs receiving more favorable state support outperformed foreign rivals, reflecting the competitive advantage gained. States imposed more punitive terms on banks when political and legal institutions were more favorable and MNBs were unable to form a coalition. States that are highly dependent on banks and where state bailouts were large relative to GDP were also more punitive. These findings highlight the importance of political behavior as a tool of strategy, and the need for coordination on banking policy across states to reduce moral hazard.

Appendices

Appendix A

Regressions on Bank Stock Returns by Country

This appendix reports regressions of individual bank stock returns around key events in the fall of 2008. The regressions are estimated by regressing individual bank stock returns on a set of independent variables:

R_MKT is the daily total return on the relevant stock market index by country. R_VOL is the one-day percentage change in realized volatility for each country’s stock market index. D is a dummy for the eight events: Lehman’s bankruptcy on 15 September, the first announcement of the TARP on 19 September (TARP_UP), the TARP’s initial rejection by US Congress on 29 September (TARP_DOWN), the UK bailout on 8 October, the French and German bailouts on 13 October, the US bailout on 14 October, and the Swiss bailout on 16 October. Ctry is a dummy variable for each country. S is a dummy for banks receiving direct state support on the following days: UK banks receiving capital (Oct 13 support UK), US banks receiving capital (Oct 14 support US), Swiss banks receiving capital (Oct 16 support CH), and French banks receiving capital (Oct 20 support FR). The regressions are estimated using daily data from January 2006 to December 2008 using three separate methods. Column (1) shows the results when using pooled OLS with standard errors clustered by bank. Column (2) shows pooled OLS with standard errors double-clustered by bank and day, using the Stata code from Petersen (2009). Column (3) shows panel regressions with firm fixed effects. The superscripts ***, **, and * indicate significance at the 1%, 5%, and 10% level.

Table A1

Table A1 Regressions on bank stock returns by country

Appendix B

Case Study of US vs UK Bailouts

This appendix provides brief case studies of the bank bailouts in the US and the UK. Both cases highlight the large number of actors involved, the importance of political and legal institutions, and the role of political power for explaining outcomes. At first glance, it is not obvious that these two countries would treat their banks differently. Economically, both are wealthy economies featuring market-based financial systems dominated by a few large MNBs that actively lobby politicians and policymakers (Duchin & Sosyura, 2012). Both countries negotiated and announced their bank capital injections at the same time. But the terms and conditions of state capital injections were very different. The UK capital was expensive (12.0% dividend), dilutive to bank shareholders (average of 49%), and included onerous conditions. The US capital was inexpensive (5.0% dividend), modestly dilutive (average of 3.4%), and came with few strings attached. In the UK, all banks were offered capital but only three accepted it. In the US, the nine largest banks accepted state capital under moral suasion from the US Treasury Secretary. What explains the difference in outcomes?

Paulson’s Gift to the US Banks

US bank capital injections were coordinated by US Treasury Secretary Hank Paulson, a former CEO of investment bank Goldman Sachs, who by nature was opposed to government intervention in markets (Paulson, 2010). Paulson was appointed by Republican President Bush in July 2006. By October 2008, a presidential election was scheduled for November and the opposition Democrats controlled the US Congress, making President Bush a lame duck. Paulson had to negotiate with both politicians and bureaucrats when deciding policy towards the banks. On budgetary matters, Paulson was answerable to the Senate Banking Committee and the House Financial Services Committee. In terms of banking regulation, the Treasury had to coordinate with the Federal Reserve Board (the “Fed”), the Securities and Exchange Commission, and other bodies. These constraints restricted Paulson’s bargaining power with the banks.

With respect to political institutions, Treasury Secretary Paulson had no ability to take unilateral action, and faced numerous political veto players. Any financial support for the US banks required the explicit endorsement of US politicians. For example, the US Congress initially rejected the $700 billion TARP on 29 September and only approved a modified proposal on 3 October. Both Paulson (2010) and Swagel (2009) stress that Paulson would never have gotten legislative authority at this time to inject capital into banks.

In terms of legal institutions, the March 2008 collapse of Bear Stearns had exposed the limits on the Treasury’s authority. Paulson learnt that the US Treasury had no legal authority to force banks to accept capital. Any capital injections would have to be negotiated with the bank CEOs, who formed a powerful coalition. In particular JPMorgan’s CEO Jamie Dimon was a vocal opponent of government restrictions on bank activities (Paulson, 2010). Some of the banks had access to alternative sources of capital. In late September 2008, for example, Goldman Sachs raised capital by selling $10 billion of perpetual preferred shares to Warren Buffett’s Berkshire Hathaway. These preferred shares paid an annual dividend of 10%, twice the cost imposed by the US Treasury for state capital injections two weeks later. Other US banks such as Morgan Stanley were negotiating with sovereign wealth funds or foreign partners to raise capital.

The US Treasury began internal discussions on bank bailouts including capital injections after the UK announced its rescue plan on 8 October (Paulson, 2010). Paulson met with hostile Congressional leaders and requested approval to use $250 billion of TARP funds to buy US bank equity. Faced with the potential failure of several large MNBs, Congress relented. Paulson instructed his staff to offer terms that would be attractive to the US banks. As Swagel (2009: 39) explains, “In order to ensure that the capital injection was widely and rapidly accepted, the terms had to be attractive, not punitive … a deal so attractive that banks would be unwise to refuse it”. The preferred shares would be non-voting, banks would be allowed to continue paying dividends (but not to increase them), and there was no outright ban on bonuses or severance pay.

Paulson met with the nine bank CEOs on the afternoon of 13 October. That morning, the UK had announced the terms of its bailout, with “much greater government control and stiffer terms than [the US]” (Paulson, 2010: 360). Paulson wanted all the banks to accept the capital to reassure markets and to avoid a stigma for the weaker banks. When JPMorgan’s CEO Jamie Dimon heard the details, he called it “cheap capital” (New York Times, 2008; Paulson, 2010: 365). All nine banks signed up. The deal, announced on 14 October, was so attractive that Veronesi and Zingales (2010) called it “Paulson’s gift”.

Darling’s Once-and-for-all Solution

The UK situation bears some similarity to the US, but with some striking institutional differences. Unlike the US where the capital injections were coordinated by bureaucrats, the UK decision to invest taxpayers’ capital was made by Chancellor Alistair Darling and Prime Minister Gordon Brown, both Labour politicians. Labour had a majority government and controlled the UK Parliament. The UK political system concentrates power in the hands of the Prime Minister and his cabinet, with fewer veto players than the US political system. Opposition politicians have no ability to block a majority UK government from taking actions. UK Chancellors therefore have greater autonomy than their US counterparts. Darling notes: “I was also struck by the fact that the US president, although frequently described as the most powerful man in the world, cannot automatically get what he wants at home. He has to horse-trade. In contrast, when I effectively wrote a cheque to buy £50 billion of bank shares in the UK, I did not even have to get specific parliamentary authority to do so” (Darling, 2011: 118).

Similar to the US, UK banks were supervised under a tripartite agreement between the Treasury, the Bank of England, and the Financial Services Authority (FSA). As fate would have it, Darling had reappointed Bank of England Governor Mervyn King in June 2008, and appointed FSA Chairman Adair Turner in September 2008. Both men owed their jobs to Darling. Together they represented a strong coalition with the same interests and motivation to act.

In terms of legal institutions, the UK Chancellor faced fewer restrictions on his ability to act. During the September 2007 bank run on Northern Rock, Darling discovered that the UK government did not have the legal authority to resolve a failing bank. If the Chancellor tried to nationalize a bank, the government could be sued by the bank’s shareholders. Darling therefore pushed through a new law in February 2008 known as the Banking (Special Provisions) Act, which gave the Chancellor legal authority. The Chancellor used this new power to nationalize Northern Rock, wiping out its shareholders, and used it again in September 2008 to nationalize the British bank Bradford & Bingley (Darling, 2011).

On 7 October, the Chancellor decided to act when RBS’s share price collapsed (Darling, 2011). Having received the go-ahead from the Prime Minister, Darling called the bank CEOs to a meeting at the Treasury and outlined the government’s rescue plan. The £50 billion proposed for capital injections was a significant sum, equivalent to 10% of the government’s annual budget. The rescue package announced the next morning did not include details on the cost or the recipients. But the press statement did make clear that there would be limits on executive pay and dividends (Her Majesty’s Treasury, 2008a).

On Sunday 12 October, the Chancellor met again with the bank CEOs who had consulted with their boards about the offer of government capital. The UK bank CEOS were divided. HSBC and Standard Chartered did not need funds, and Barclays preferred to raise equity privately and avoid public scrutiny of its salaries (Darling, 2011). Lloyds and HBOS, who had agreed to merge, had no access to private capital and were desperate. They requested £17 billion of government capital in the form of £13 billion of common shares and £4 billion in preferred shares, representing a 44% voting stake in the combined entity. RBS was also desperate and required £20 billion of government capital, consisting of £15 billion of common shares and £5 billion of preferred shares, representing a 63% voting stake. As a condition for the state capital injection, the Chancellor fired RBS’s CEO and Chairman of the Board, appointed independent directors to both banks, and suspended bonuses for existing board members. The banks also committed to maintain lending at 2007 levels (Her Majesty’s Treasury, 2008b). When the capital injections were disclosed on October 13, the share prices of these three UK banks fell by −27.5% on average.