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New & Now: Fall 2008

Darkness Visible

Trains on Time

Vision Quest

Plastic War

Disappearing Doctors

Bad Business

Early Warning

Protective Paste

 

Illustration by Blake Dinsdale.

Bad Business

Who pays for political malfeasance and cronyism? We all do.

As recent turmoil in the international financial markets shows, a lack of transparency can threaten the very foundations of healthy market economies. Credit default swaps and collateralized debt obligations notwithstanding, few circumstances pollute market operations more directly than cronyism and corruption. It's a fact often noted but seldom studied systematically -- until now.

Dishonest dealings bring greater credit risk, more expensive bond payments, increased use of external credit enhancements (such as bond insurance) and the utilization of lower quality underwriters, says Sandra Mortal, an assistant professor of finance at MU.

The bottom line, Mortal says, is that fiscal malfeasance affects the bottom line. "Corruption is expensive. To avoid or decrease the effects of corruption, issuers are paying for credit enhancement, such as bond insurance. Who's paying for the higher yields and the underwriters' fees? It may eventually be the taxpayer."

Mortal most recent study, co-authored with researchers Alex Butler of the University of Texas at Dallas and Larry Fauver of the University of Tennessee-Knoxville, bolster arguments made by good government advocates the world over. Corruption doesn't just undermine officials' legitimacy and credibility, they found, it undermines their ability to execute cash transactions, to facilitate trade and to promote economic growth and development.

To make the point, Mortal, Butler and Fauver sought to quantify the fiscal effects of federal corruption convictions involving "pay-to-play" schemes; specifically, costs incurred when investment banks won underwriting contracts by making campaign contributions to legislators who, you guessed it, controlled the process of selecting underwriters.

The results, presented at a professional conference in New Orleans earlier this year, showed that cities with fewer corruption convictions tended to have better bond ratings and issue lower yielding -- and thus less expensive -- municipal debt. Clean governments also tended to employ better quality underwriters. In addition, Mortal and her co-researchers found, issuers in corrupt states were more likely to use expensive bond insurance to improve credit ratings and reduce yields, thus costing taxpayers more money.

Their paper detailing these insights, Corruption, Political Connections and Municipal Finance, was named "Best Paper in Fixed Income Research" by the Financial Management Association International, a scholarly consortium based in Tampa, Fla.

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Published by the Office of Research.

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