When Do Special Interests Run Rampant? Disentangling the Role of Elections, Incomplete Information and Checks and Balances in Banking Crises

Abstract

Government responses to banking crises are less likely to favor special interest groups when elections are near, voters are better informed about the costs of inefficient government decisions, and governments have multiple veto players.

Keefer investigates the political determinants of government decisions that benefit special interest groups - especially government decisions to deal with banking crises. He finds that the better informed the voters, the more proximate elections, and the larger the number of political veto players (conditional on the costs to voters of relevant policy decisions), the smaller the government's fiscal transfers are to the financial sector and the less likely the government is to exercise forbearance in dealing with insolvent financial institutions.

The results suggest that policies that might be appropriate for mitigating banking crises in the United States might be less effective in settings where voters are less informed, where elections are less competitive, and where there are fewer veto players, because in these settings checks and balances are missing. These policies include:

• Disseminating information about the costs of inefficient government decisions. • Improving the structure of legislative regulatory oversight. • Intervening early in insolvent banks. Keefer concludes that the more veto players there are, the less likely policies are to favor special interest groups (contrary to previous views). Moreover, the closer the elections, the less likely policies are to favor special interest groups.

This paper - a product of Regulation and Competition Policy, Development Research Group - is part of a larger effort in the group to explore the policy consequences of political and social institutions.