Sunday, November 20, 2011

How Congress Can Game the Stock Market


Peter Schweizer’s new book Throw them All Out, (full disclosure: Peter is a friend and I had a miniscule part in editing the book) chronicles the long running graft in Washington.    Congress is exempt from insider trading laws, which allows them to profit in ways none of the rest of us can.  This reality has created an emerging industry of gathering business intelligence by trolling the halls of Congress.  In the movie Wall Street Gordon Gekko taught Bud Fox the value of information and where to get it, but instead of stalking Gekko’s archrival Sir Larry as Fox did in the movie, now Bud would be trolling the halls of Congress.  Given the incentives and complete moral breakdown of the system, this outcome should not really be surprising.  The federal government has been accumulating power for years and with power comes opportunity to use it in whatever way one wishes.  I cannot say the current political class is any more corrupt than its predecessors were but I can say there seems to be more opportunities than before.


The missing part of Schweizer’s otherwise excellent analysis is how the regulatory process enables all of this.

These profit opportunities are only possible if the Congressmen actually have the information and that is where the regulatory process comes in.  The regulatory process provides Congressmen numerous opportunities to gather that inside information on which they can trade.

The process is pretty simple really:  Congress proposes or passes some new law that requires regulation of an industry.  This gives the industry an incentive to influence the legislation and the ensuing regulations and thus start lobbying.  The lobbying effort involves a number of goodies accruing to the members of the oversight committee as well as campaign cash.  This part of the process we all know.  But the next step is rather insidious, in the name of protecting the people the committee holds hearings, has taxpayer paid staff do research and grills the business managers about their operation, when in reality it is nothing more than intelligence gathering for the next stock trade.  The ongoing lobbying provides opportunities for continuous information exchange as well and before you know it the Senator has beaten the market again.  Statistically, we should not expect anyone to consistently beat the market, especially not a group of amateurs and yet members of Congress are beating the market by several standard deviations above the professionals.


The primary way the federal government has been increasingly controlling our lives in the name of protecting us is the very way they are getting wealthier than us.  Committee hearings, subpoena power, moral suasion, media embarrassment not to mention campaigning are all tools to gather business intelligence.  The process leads to regular interaction with business leaders where information is easily exchanged under the guise of the public good.  Information is the lifeblood of markets.  Stock prices move on information and how investors perceive that information will impact a firm’s prospects.  Access to information and the ability to act on it can allow anyone to earn a profit, even a member of Congress.  The real question is how come they are not doing better?


Then there is the multi-million dollar lobbying industry in which money and information are the coin of the realm.  The right committee assignment can be very profitable, it determines what information a member has access to by which industries his committee regulates.  This is why there is so much competition for plum committee assignments, the best and most cherished committees are the ones with most oversight authority, the ones that have the most information flowing through them.  The government official is worse than a street thief, at least you know what the thief on the street is doing, the government official hides behind his office and tells us it is for our own good.

Business has been part of this and enabled it but from their perspective, what choice do they have?  The regulatory state is so intrusive and widespread that if they do not play the game they get frozen out or persecuted.  Look at Microsoft.  In 1995 Microsoft had a minimal Washington presence and spent next to nothing on lobbying, about $16,000.  Then came an anti-trust lawsuit which resulted in Microsoft ramping up its political presence so by 2000 it had a full blown PAC with a $1.6 million budget and donated almost $5 million to candidates, with employees chipping in as much.  Soon after the shake down was complete, er, justice was served, as the case was ‘unexpectedly’ settled in 2002.

Schweizer proposes a number of changes to the law aimed to prevent members from trading and profiting on their access to information.  I am for them, but as long as Congress has and continues to amass regulatory and oversight authority there will always be suspicion on our part and members who think they can get away with it.  These proposals will have two affects; it will end much of this but drive the remaining deep underground and harder to find.  The real cure is to remove the occasion to sin, their access to information must be cut off. 

The regulatory state must be dismantled, if we expect this to truly stop.

Big Government