Congress, Insider Trading, And The 2008 Financial Crisis

More evidence of the extent to which Members of Congress have profited from the inside information they receive.

Following up on a piece which detailed the manner in which Members of Congress have profited off of what in what other situations would be inside information, which James Joyner has already covered, The Washington Post reported Sunday on the extent to which many of these same officials were able to adjust the portfolios in advance of the worst of the 2008 financial crisis after meeting with Treasury and other financial officials:

In January 2008, President George W. Bush was scrambling to bolster the American economy. The subprime mortgage industry was collapsing, and the Dow Jones industrial average had lost more than 2,000 points in less than three months.

House Minority Leader John A. Boehner became the Bush administration’s point person on Capitol Hill to negotiate a $150 billion stimulus package.

In the days that followed, Treasury Secretary Henry M. Paulson Jr. made frequent phone calls and visits to Boehner. Neither Paulson nor Boehner would publicly discuss the progress of their negotiations to shore up the nation’s financial portfolio.

On Jan. 23, Boehner (R-Ohio) met Paulson for breakfast. Boehner would later report the rearrangement of a portion of his own financial portfolio made on that same day. He sold between $50,000 and $100,000 from a more aggressive mutual fund and moved money into a safer investment.

The next day, the White House unveiled the stimulus package.

Boehner is one of 34 members of Congress who took steps to recast their financial portfolios during the financial crisis after phone calls or meetings with Paulson; his successor, Timothy F. Geithner; or Federal Reserve Chairman Ben S. Bernanke, according to a Washington Post examination of appointment calendars and congressional disclosure forms.

The lawmakers, many of whom held leadership positions and committee chairmanships in the House and Senate, changed portions of their portfolios a total of 166 times within two business days of speaking or meeting with the administration officials. The party affiliation of the lawmakers was about evenly divided between Democrats and Republicans, 19 to 15.

The period covered by The Post analysis was a grim one for the U.S. economy, and many people rushed to reconfigure their investment portfolios. The financial moves by the members of Congress are permitted under congressional ethics rules, but some ethics experts said they should refrain from taking actions in their financial portfolios when they might know more than the public.

“They shouldn’t be making these trades when they know what they are going to do,” said Richard W. Painter, who was chief ethics lawyer for President George W. Bush. “And what they are going to do is then going to influence the market. If this was going on in the private sector or it was going on in the executive branch, I think the SEC would be investigating.”

Of course they would. Indeed, people like Michael Milken and Martha Stewart were subjected to intensive SEC and FBI investigations over the mere suggestion that they had traded on information that they had received from insiders. Milken’s actions were, of course, far more serious than Stewart’s and Stewart ended up being convicted only of lying to Federal agents, but the principle remains the same. The law has been eminently clear for years that trading on material, non-public information is forbidden. Unless, that is, you happen to be a member of Congress.

As the Post report goes on detail, as Treasury and other officials continued to brief Members of Congress on the state of the economy both during the financial crisis and in the time leading up to it (when most Americans were not aware of just how bad things actually were), many Members of Congress began to shift their assets out of risky investments and into more secure investments like Treasury securities. If you had an inclination that there was a major financial crisis on the way, this would be an incredibly smart move, and the possibility that Members Of Congress were able to do so earlier than most other Americans because they were getting advance signals of trouble ahead raises some rather obvious concerns that they were trading on information that was unavailable to most other members of investing community.

It was partly in response to reports about practices like this late last year that Members of Congress were essentially shamed in to passing the STOCK Act, which purports to address the issue of Members of Congress who trade stock based on information they learn in the course of their duties. To some extent, the STOCK Act contains provisions that should help to combat some of the worst aspects of Congressional insider trading. The law precludes Members from trading on information they learn during the course of their duties, for example, which suggests that the activities that occurred in 2008 would be illegal today. It also requires them to report trades every 45 days, instead of once a year as previously required. There are also restrictions on participation in Initial Public Offerings in that Members can only participate in I.P.O.’s that are open to the general public. Why most of this wasn’t already illegal is, of course an open question.

At the same time, though, there are loopholes in the act that are wide enough to drive a dump truck filled with stock certificates:

What’s most disturbing about the STOCK Act is not so much what it contains, but what it omits.

When a hedge fund or an influence peddling individual wants inside information, they can still buy it – by paying members of Congress or other high level officials for something called “political intelligence.” This rogue but still legal practice of gathering information from lawmakers and Hill aides is regularly used by Wall Street to steer money into profitable investments. It’s nothing more than legalized cheating, because he with the most money and political influence wins.

CASE STUDY: Former US Treasury Secretary, Henry Paulson sold political intelligence when he tipped off hedge funds about Fannie Mae’s rescue in 2008 while he was serving as the U.S. Treasury Secretary. Paulson’s hedge funds pals made billions in illicit profits. That type of unethical conduct is still legal under the “new and improved” STOCK Act.

Here’s another gaping omission: The STOCK Act still allows elected officials to own stock in industries they can affect with their political power. For example, a senator that owns an energy stock can still draft and pass laws that benefit his investment holdings. Isn’t it obvious that allowing this kind of seedy behavior badly waters down the effectiveness of the STOCK Act?

Yea, it’s fairly obvious that it does, and the fact that Congress couldn’t pass a version of the act with provisions covering those situations in it is really rather pathetic. How it is considered at all acceptable that a Member Of Congress would be able to own stock in companies that they can have an impact on with a piece of legislation, or a committee hearing, or even just a speech. Is it any wonder that people are cynical about politics when things like this are legal?

There is one solution to all of this, of course, but it’s one that people who run for Congress and the Senate aren’t going to like very much. Just as with Presidents, we should require Members of Congress and the Senate to place their assets in a blind trust while they are in office. Given the nature of their job, we can perhaps make an exception for that for the family residence and such things, but as a general principle I don’t see why this should not be the rule for everyone, not just the President and Vice-President. There are some practicalities to consider here, of course, since it means that some members of Congress will have their assets in such a trust for only a short period of time if they only end up serving one or two terms in office, but that is hardly a reason to reject the idea considering that President’s term can last as little as four years. By placing their assets in a blind trust, Members of Congress would be able to reassure the public that they are not personally profiting from the information they gain while they are serving their constituents, and that they aren’t engaging in the obviously conflict-ridden task of regulating the very industries they are invested in.

This would all have to pass Congress, of course, and it doesn’t seem like it would be a very easy task to get it all the way through. Then again, the STOCK Act had languished in obscurity since 2006 until it finally got passed, so maybe it’s time for a few brave Members of Congress to take up the task, and if they won’t do it, maybe we need to demand that they do.

FILED UNDER: Congress, Economics and Business, US Politics
Doug Mataconis
About Doug Mataconis
Doug holds a B.A. in Political Science from Rutgers University and J.D. from George Mason University School of Law. He joined the staff of OTB in May 2010. Before joining OTB, he wrote at Below The BeltwayThe Liberty Papers, and United Liberty Follow Doug on Twitter | Facebook

Comments

  1. Herb says:

    [Boehner] sold between $50,000 and $100,000 from a more aggressive mutual fund and moved money into a safer investment.

    At age 62, one wonders why Boehner didn’t do this sooner and without the prompting of inside info….

  2. steve says:

    I like the idea of blind trusts, but am suspicious about how blind they might end up being. Do you require a sell off of all assets and redistribution by the new asset manager? If not, someone with an energy heavy portfolio will probably still be energy heavy for quite a while if a pro is managing it, as they are not likely to make large moves right away. What about real estate and non-stock assets?

    I think an alternative like requiring that all trades be conducted on a publicly accessible website so that we (and I do mean we, not some regulatory agency) can monitor what they are doing would be feasible. This should be partnered with a simple statement that no trading is allowed on insider information. I think this should also include real estate purchases and entry into partnerships.

    Steve

  3. Tsar Nicholas says:

    There is one solution to all of this, of course, but it’s one that people who run for Congress and the Senate aren’t going to like very much. Just as with Presidents, we should require Members of Congress and the Senate to place their assets in a blind trust while they are in office.

    FYI, nobody is required to place their assets in blind trusts, whether the president or otherwise. The requirement for federal elected office holders is that they report their holdings publicly, with an exception for those who choose to place their assets in qualified blind trusts.

    That aside, a requirement of transferring assets to a blind trust in my view is a bit totalitarian. Since when do public officials have lesser private property rights than the rest of us?

    What I would do is I’d beef up the reporting rules and then I’d eliminate all exemptions and loopholes for application of standard securities laws. Make them report their holdings to the SEC every month. It won’t be rocket science to figure out if they’re trading on inside info. If they do have suspicious trading then they get investigated and if necessary prosecuted. Like anyone else. With that framework in place they’d stop trading on inside info, right quick.

    Then for the related ethical issue of conflicts of interest without actual insider trading I’d amend their internal ethics rules flatly to prevent it. If you’re on a House committee regulating the energy sector, for example, it would be unethical for you to hold energy stocks and thus you could be censored, etc., unless you choose to place your assets in a qualified blind trust.

  4. Modulo Myself says:

    Does being briefed by Treasury officials and then selling off stock would actually actually qualify as insider trading?

    Also, Milken ended up being busted on RICO charges. Insider trading was the least of what he had committed.

  5. grumpy realist says:

    @Modulo Myself: It’s very hard to prove insider trading. Also not helped by the idiot economists (you know who you are) who believe in the strong theory of stock information (basically, that stock prices mirror all knowledge about a stock, both open and hidden) and think there’s nothing wrong in insider trading.

    The fact that a feeling that the playing field is rigged against them means that fewer people will play is, of course, totally ignored by these nitwits.

  6. The thing that occurred to me was that congressmen should set their prior investments, diversify them, and then lock them for duration of service. Any new investments made while in office should be in the government’s own Thrift Savings Plan index funds. Buy only.

    That should protect their nest egg, allow them to invest further, but prevent shenanigans.

    Ah, well. I doubt any changes will be made.

  7. Its very difficult to maintain the economy trading during any session but after that government did the best effort to control it.