Study: Top Bank Execs Saw the Crisis Coming and Sold Their Company’s Shares

Yves here. So much for “whocouddanode”.

By Ozlem Akin, Assistant Professor of Finance at Ozyegin University, José M. Marín, Professor of Excellence at Carlos III University of Madrid, and José-Luis Peydró, ICREA Professor of Economics at UPF, Barcelona GSE Research Professor and Research Associate of CREI. Originally published at the Institute for New Economic Thinking website

Banking crises are recurrent phenomena that often trigger deep and long-lasting recessions with enormous economic and political costs. Yet the empirical evidence is now overwhelming that banking crises do not come as bolts from the blue – they come after periods of strong bank credit growth and risk-taking, often associated with real-estate bubbles. The crisis of 2008 was no different: it is clear that banks took on more and more risk as bubbles swelled in many countries.

A key research question is why banks take such excessive risks. Many defenders of finance in the recent crisis suggest that the giant institutions were really taken by surprise when the bubble popped. Otherwise, runs the argument, why wouldn’t they have sold off all the junk? The implication of this “behavioral” view is that banks take on high risks because, for example, they neglect unlikely tail risks and have over-optimistic beliefs about the economy.

But there is another, less innocent answer: explicit and implicit bank guarantees by states, such as deposit insurance, provision of central bank liquidity, and bail-outs make it rational for banks to take on excessive risk. Sometimes this “moral hazard” point of view is combined with an “agency failure” account, which stresses how bank managements can escape from control of their shareowners and holders of bank debt.

These views of why banks take on excessive risk are testable. In a recent paper we tackle this question by providing sector-wide evidence from US. We examine what bank insiders were doing before the crisis and use executives’ trading with their own bank shares as a proxy for their understanding of risk before the crisis hit in 2007-08. Specifically, we investigate the relationship between bank’s performance in the crisis and bank executives’ sale of their own bank shares in the period prior to the crisis.

The paper finds that the top executives’ ex-ante sale of their own bank shares predicts worse bank returns during the crisis; interestingly, effects are insignificant for independent directors’ and other officers’ sales of shares. That is, effects are substantially stronger for the insiders with the highest and best level of information, the top five executives. Moreover, the top five executives’ impact is stronger for banks with higher ex-ante exposure to the real estate bubble, where an increase of one standard deviation of insider sales is associated with a 13.33 percentage point drop in stock returns during the crisis period. Our results suggest that insiders understood the heavy risk-taking in their banks; they were not simply over-optimistic, and hence they sold more of their own shares before the crisis.

These results have not only implications for corporate finance or banking theory based on agency problems, but also for an understanding of financial crises and public policy – especially on the recent prudential policy measures across both sides of the Atlantic. Our evidence is consistent with agency problems in the banking industry being important for risk-taking. Accordingly, the recent policy initiatives to raise bank capital (including Basel III) or enforce macroprudential policies may be useful for limiting excessive bank risk-taking. If high risk-taking in banks were exclusively due to behavioral reasons, then some of the new prudential policies providing better incentives for bankers would not matter at all.

No less importantly, however, our results have policy implications for the regulation of insider trading in banks. Insiders’ ability to trade (selling shares of their own bank when they anticipate that their excessive risk-taking may lead to large losses) may exacerbate conflicts of interest between them and shareholders, bank creditors, and even the other employees of the bank who did not or could not see what was coming. Banning trading by bank insiders might reduce excessive risk-taking by banks and operate as a (partial) substitute for bank capital regulation or macroprudential policies. Whether a total ban on insider trading would be justified, however, requires further analysis, since that may have other effects that also need to be assessed.

Akin, O, Marin, J and Peydró, J-L. 2016. “Anticipating the Financial Crisis: Evidence from Insider Trading in Banks”. London, Centre for Economic Policy Research DP 11302.

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  1. Steve H.

    There’s a quote out there, something like ‘the business of Wall Street is inside information.’

    Wish I could find the source. In the modern speculative economy, it seems that what middle-school economists call ‘creativity’ is really about creating a monopoly on a moment of information, and knowing the timing of when to flip it and cash in.

  2. griffen

    Collective greed combining with 25 to 30x levered balance sheet equals incredible upside potential, and those splendid annual payouts.

    Yep, who coulda thunk it.

  3. John Wright

    One can wonder if the bank executives will tout the study because it shows they DO really know what is going on and are not unaware of their business risk.

    After all, they can pitch that as evidence they deserve their high pay as they are on top of the action.

    Maybe Alan Greenspan can be trotted out to do the PR work.

    That’s the ticket, spin the study for executive pay justification.

  4. Watt4Bob

    We knew about it.

    In the three years leading up to the Lehman Moment, (2006-2008) many of us who were paying attention were blogging at the Moneybox forum at Slate magazine, owned by the Washington Post.

    We were telling the truth and taking note of the fact that those in charge of our economy were obviously preparing for trouble.

    They were busy passing end-game legislation that had the effect of pulling up the ladders behind them, and blocking the exits for the rest of us.

    Just about the time that the whole house of cards collapsed, Slate killed the honest exposition the denizens of Moneybox provided by ‘redesigning’ the Slate blog, and in the process wiping out any trace of the ‘alternate’ history that our collective comments provided of the causes and the nature of the economic collapse we had witnessed.

    I found my way over to the Firedoglake blog, others found homes at Angry Bear and here at NC.

    As Firedoglake gained prominence as a recognized source of the truth, especially as concerns the increasingly obvious kayfabe surrounding the legislative push for healthcare reform, it was increasingly attacked by determined trolls, and cyber shenanigans, which I am sure did not help Jane Hamsher’s health, which was instrumental in bringing and end to FDL as we knew it.

    NakedCapitalism is one of, if not the best current sources for straight forward, truthful analysis of current political and economic reality, which means that readers of this blog can, and do “see it coming” so to speak, and so, predictably, this site becomes a target for trolls and DDOS attacks.

    So, yes, those bank execs saw it coming, they prepared their exit strategies, all the while, right up to the end, cheerleading (hearding) the rest of us to commit everything we had to join the ‘ownership society‘, and at the same time interfering with our ability to learn and share the truth.

    Now it looks to me as if we are about to face the worst of what we obviously have seen coming, and that is, the folks who’ve been propagandized for the last 20 years by Rupert Murdock, and Roger Ailes’s Fox News Channel have found their messiah, a leader to put and end to all their fears.

    Some of us, not an insignificant number, see what’s really happening, and hear, loud and clear, the threat implicit in Trump’s speech.

    “Don’t get in my way, or you will be hurt.”

    And the crowd goes nuts, USA, USA, USA … GOTT MIT UNS!

    1. John k

      So you see Hillary as the option to rein in the banks?
      Have you noticed their relative positions re glass steagall?
      Or same regarding bank payments for services expected?
      Or we could segue into warmongering, and the need to confront Russia and China?

      Liberals are repulsed by racism, particularly overt, which trump was, which was highly effective in taking over a racist party. Try to hold your nose, maybe helpful to remember
      Clintons have been quietly racist, supporting heavy penalties for crack vs powder, mandatory jail terms, privatizing jails, arming police, and most of all promoting neolib trade and other policies that hurt all those with less Ed, but especially minorities.
      Trump claims he’s a builder and wants lots of infrastructure spending, might even get congress to agree. Hillary just wants more wars.

      1. RepubAnon

        The thing is – Democrats admit their mistakes, while Republicans refuse to ever admit that their policies don’t work. See e.g. Kansas.

        As to whether Hillary Clinton would be more likely to rein in the banks than Donald Trump, my initial reaction is to point out that Donald will say anything to please a crowd. However, he can’t be trusted to keep his word.

        Hillary Clinton, however, has had a near-defeat experience handed to her by Bernie Sanders. She’s not one to simply ignore unpleasant facts – so I expect that she’d at least veto any gifts to Wall Street passed by a Republican congress. I also expect that she’s had enough experience with double-dealing Republicans to realize that a “Grand Bargain” is not in the cards – especially after watching the Republicans extract one-sided concessions from President Obama during his first term, go back on their word, and use those same concessions to defeat Democrats during the midterms. Remember, she’s had years of first-hand experience with Republican hypocrisy and double-dealing.

        As to Hillary “just wanting more wars” – don’t be silly. Bill Clinton won with “it’s the economy,stupid” – you can be sure that Hillary wants to grow the economy.

        In short, I expect Hillary to use Bernie Sanders to promote extremely liberal policies, and then offering to compromise by proposing liberal policies. Recognize the tactic? It’s the one Republicans have used for years to shift the political center to the right. Hillary will push it to the left.

        In short, Bernie Sanders’ supporters will be free to continue to push his policies at the federal, state and local level during a Hillary presidency. If Donald Trump gets elected, we’ll see national voter suppression legislation, Supreme Court justices willing to rule that the First Amendment doesn’t protect language that might incite criminal activity, and a “law and order” administration willing to imprison anyone criticizing Republicans, the police, polluters…

        1. ambrit

          You are ascribing too much “sweetness and light” to H Clinton. Oh, and are you doing your subbotnik for CTR? I hear that the Kochs used to pay real coin of the realm for their trolls. By trolling in a superior manner here, you deserve actual recompense for your efforts. Stand up for yourself! Tell the DNC that, if they want quality ‘targeted’ commentary, they’re going to have to pay for it!

          1. Ian

            Who says they aren’t. The person has created a very plausible sounding yet false narrative that is completely at odds with the very high level analysis and breakdown that occurs on NC on a regular basis. This narrative is not for us, it is for the casual passersby that don’t have NC as a regular backdrop to help form their perspective. Reeks of a Pro.

        2. william

          Quick you forgot your meds.
          I bet were not able to keep your MD as promised… is that your problem?
          Possibly, you have been distracted by the Obama declared JV team killing tens of thousands in Iraq, Syria and now in Western Europe.
          Kaine was the ideal pick by Clinton so that his ethical violations fit her same pattern.
          Reports are suggesting she wants Brian Williams to be her new communications director. Too bad he wasn’t the sole observer of her of flying into Bosnia and running through sniper fire at the airport…unfortunately even NBC video proves Clinton was lying…AGAIN.
          Do you think Clinton will have a convention panel including J. Flowers, J. Broadderick, P. Jones, K. Willey and M. Lewinsky discussing how H. Clinton fights “for” women!

  5. TomDority

    The business execs at the financial institutions were lying when they said they did not see the crash coming. They must continue to insist that they could not have seen it coming because, if they did admit to seeing the crash (which they did) they would legally admit to the crimes committed and to the misleading of the american public and lying to congress.
    Their insistence upon ignorance is their defense to criminality. As such, they should not get a pass on both. Either they are not worth their pay as they are incompetent or they are competent and deserve jail.

  6. Benedict@Large

    So what this means is that Eric Holder too was lying; that there certainly was available and sufficient evidence of fraud and various other illegal activities by specific persons.

    1. TomDority

      True. As pointed out at this site and, by William Black…. the FBI reported 4 years before the 2008 crisis that endemic fraud was being committed and it would lead to a crisis…..The FBI reported that the fraud was being committed by the lenders and not the liitle guys/homeowners…..So the response at Justice was to define mortgage fraud for the FBI as that committed by the homeowners – the little guys – it truly was the FBI being told to look 180 degrees away….

  7. Ulysses

    These are the shady crooks that Sen. Tim Kaine feels are overburdened by regulations!!

    “At his wrath the earth shall tremble, and the nations shall not be able to abide his indignation.”

    [Jeremiah 10:10]

  8. Sound of the Suburbs

    It certainly wasn’t a surprise to everyone.

    Irving Fisher looked at the debt inflated asset bubble after the 1929 crash when ideas that markets reached stable equilibriums were beyond a joke.

    Fisher developed a theory of economic crises called debt-deflation, which attributed the crises to the bursting of a credit bubble.

    Hyman Minsky came up with “financial instability hypothesis” in 1974 and Steve Keen carries on with this work today.

    Steve Keen saw the debt bubble inflating in 2005.

    There are those that know and the clueless bankers, central bankers and mainstream economists that don’t know what’s hit them.

    2008 – “How did that happen?”

  9. Sound of the Suburbs

    After the bubble bursts you enter balance sheet recessions that Japan knows all about after having been in one for 25 years since 1989.

    They found out what to do:

    You need fiscal stimulus, monetary stimulus doesn’t work and austerity makes them worse.

  10. TedWa

    Behind the curtain – It’s a war between the rich and the poor is all – the rich who control our government and the poor here only to be pawns to be sacrificed on the altars of the greed. Barry defends the rich as he always has – when he ran and spoke as protecting the poor and weakest. It’s not a matter of a woman winning the Presidency, its a matter of the rich staying in power with all their corrupting influences. We should act grateful that the elites would deign to change tour perceptions by electing a semi-black man and a woman? They are so beneficent. WoooHooo! Pawns we are. Charades we are

    1. TedWa

      Barry sided with the rich in a class war and when we were at our weakest. Fk em, I’m voting Trump. If a revolution is coming, why should we frogs wait till the water comes to a boil? Because it pleases the elites? Let it come, I’m not interested in waiting for more hoax and chains. Throw in the grenade that is Trump. WoooHoo !

      1. TomDority

        Not so enthralled with some of your labeling of folks….. but, throwing in the grenade that is Trump has crossed my mind… I mean, if Hillary is going to just stay on Obama’s course…I am not to thrilled at voting for her (aside from all the other negative she brings)
        For example, when the Horizon disaster occurred in the Gulf….Obama went on TV to announce that their existed regulatory capture in the oIL industry…..the fox guarding the hen house….a perfect time for him to mention the same in the financial industry……instead, not a peep.
        So the question is, Where does Hillary stand on the TPP? Where does she stand on trade deals hatched in secret that threaten our own laws, the environment, our safety etc.
        Anyway, the grenade that is Trump has crossed my mind.
        I prefer to continue the movement and momentum that Bernie Sanders imparts with his policies…….just have not figured out if the disaster that would be Trump could help hasten the movement or if Hillery’s disaster would be quicker. I am about 51 to 49 in favor of the grenade

        1. TedWa

          We know HRC is the greatest evil in being more effective at it. Trump? Not so much.

          His Presidency might make the democrats act like democrats again. Hope and change. But consider, FDR was one of the elites and he saw there was great need for change. I see Trump as – Why should he bother risking his life? In that way he is very similar to Bernie

        2. TedWa

          I don’t believe his candidacy is a run for more greed or power. HRC’s obviously is. Characterize (labeling) ? Am I being out of bounds? If so I sincerely apologize for offending your sensibilities. I’m just bearing witness from the bleachers.

          Thinking of the Clintons history, speaking truth to power will get you disappeared – if you get my drift.

          1. TomDority

            Not at all out of bounds….it just seems sometimes that when labeling persons as such and such, it undermines and obfuscate the underlying policy/issues that need to be addresssed.

        3. John k

          But a vote for Hillary doesn’t just get more bank fraud, you also get more wars!
          She’s a twofer!

      2. horostam

        am i crazy in thinking that words, however empty, matter? obamas “socialist” (lol) health care plan lead to de-tabooing the term. i think this was a huge part of what would eventually make bernie so palatable. now, hillary is forced to call herself a progessive and at least not condemn the sanders rhetoric. this matters for idiots, the overton window must stay safely shifted for them, or else progessive stuff will seem too crazy… hillary wont be around forever, i dont really like her but maybe we should have vision beyond the next election, see what becomes possible long term

        or am i being too “pragmatic?”

        also, i like black people and donald wont do shit for them

        1. NotTimothyGeithner

          Obama ran on far more progressive plan and single layer was part of the lexicon in 2008. The time was 2009. Democrats ran on raising taxes, ending wars, and Healthcare, and they won. When they added new wars, bailed out the wealthy, and passed ACA, they lost.

          1. horostam

            those things remain in the lexicon, despite intentions, and hillary is not in a position to denounce them. shes not good at rhetoric and pr, and a real progressive down the road would have to be superficially accepted

            i just dont like trump

  11. Chauncey Gardiner

    More evidence of control fraud and white collar crime, as Bill Black has so well articulated on so many occasions. Sadly, many politicians and senior officials seem to have been part of the problem, rather than contributing to a solution. Wonder what would happen if we we were able to get substantive campaign finance and revolving door reforms implemented? Also, is there is a statute of limitations regarding control fraud and insider trading violations, as well as the potential for clawbacks?

    It is constructive to read that restoration of the Glass-Steagall Act is a plank in the platforms of both legacy political parties. That these few people can and have put the entire payments system and our savings at risk through their behavior is unacceptable.

  12. John Rose

    Very little is being said here about the early signs leading to personalized dictatorship. Trump spells out his scary scenario, stretching all truth to evoke paranoia. He calls for law and order, praising the police as enforcers. He identifies himself, and only himself as the savior promising action “immediately” which will require and justify ignoring law and constitution. He demonizes his opponents. And he trots out his (current) trophy wife and pretty children as his lieutenants and eventual successors in a dynasty of absolutism.
    I am looking for a source for bumperstickers “Trump for Dictator” so more folks will pay attention to the signs.
    Hillary and company stays within the broad parameters of constitutionality, at least, although our continued economic enthrallment and the brown people likely to die weakens my comfort in that small solace.

    1. Watt4Bob

      Trump is the messiah that Murdoch and Ailes have been stumping for since 1996.

      That’s a lot of money, forward thinking and advance work, and Trump didn’t have to pay for it.

      Ailes got them riled up, and primed, now Trump is going to see what he can do with them.

      Now it’s up to us to convince those who are dispirited by the whole thing, that it’s still necessary to vote in order to forestall the looming darkness.

    2. Skippy

      Trump is just playing a piano key that was already there, it was just under a thin vernier, see G. Washingtons papers.

      “Washington’s commitment to religious liberty was not limited to Christians. In Washington, American Jews found a sincere friend.

      In a 1790 missive to the Hebrew Congregation in Newport, Rhode Island, perhaps his most eloquent and famous pronouncement on religion, he demonstrated an ability to speak the religious vernacular of his audience.

      “May the children of the Stock of Abraham” (Acts 13:26), the president wrote, flourish in this land where everyone, in the words of an ancient Hebrew blessing, can “sit in safety under his own vine and figtree, and there shall be none to make him afraid” (Micah 4:4).

      More important, he substantively described a distinctively American view of religious liberty:

      The Citizens of the United States of America have a right to applaud themselves for having given to mankind examples of an enlarged and liberal policy: a policy worthy of imitation. All possess alike liberty of conscience and immunities of citizenship. It is now no more that toleration is spoken of, as if it was by the indulgence of one class of people, that another enjoyed the exercise of their inherent natural rights. For happily the Government of the United States, which gives to bigotry no sanction, to persecution no assistance requires only that they who live under its protection should demean themselves as good citizens, in giving it on all occasions their effectual support.

      This letter is notable for Washington’s clear articulation of America’s greatest contribution to, and innovation of, political society – the abandonment of a policy of religious toleration in favor of religious liberty.

      The distinction between toleration and liberty is as follows: the former assumes an ecclesiastical and/or political establishment that extends or withdraws permission to practice one’s religion. The latter maintains that the free exercise of religion is a natural, inalienable right possessed equally by all citizens and placed beyond the reach of civil magistrates.”

      He also made the same comments wrt the tradesmen working on Mount Vernon, including Hindus and those that followed the teachings of Muhammad.

      My point is the radicalization was not so much an internal event, with in the Muslim faith, as it was external forces over some period of time and environmental condition from constant war between super powers as economic proxies. In Tumps case is argument is not based on ownership of those actions and uses the events as a Bernays social PR tool to engage the irrational fears of his mostly White male followers…

      Disheveled Marsupial…. its like shooting fish in a bucket….

  13. john bougearel

    Aggressive insider selling happens with or without financial crises coming. And insider selling is not the exclusive domain of banksters selling their shares before crises occur. This is just what insiders do as a matter of business and habit. In fact, insiders have been aggressive sellers of their own shares post 2008-09 through 2016 all the while doing record stock purchase buybacks. Stock buybacks have had far more predictive value than insider selling since 2009.

    As a more than casual observer of insider selling for almost 30 years now, it is hard to ascribe or buy into the premise that insider selling has “predictive value.” Like a non sequitur, it does not follow that insider selling leads to significant stock price declines. While I will pay heed to large stock buyback programs, experience has taught me to disregard this supposed “indicator” or “signal.” I have long ago tossed this signal into the noise pile.

    Regardless of the observed “increase of one standard deviation of banks insider sales” being associated with bank stock price declines during the stock market crash, we must also bear in mind that almost all stock prices declined precipitously.

  14. Robin Kash

    So long as banks are private we will have excessive risk-taking. Not nor Clinton nor Sanders address the issue. Most radical is Sand er s’ proposal to break up the big banks. What is needed is for the US government to nationalize the Fed and it’s owner banks and turn them into public utilities.

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