John Ransom

The House yesterday passed a new "reform" measure aimed at curtailing the practice of trading on securities with inside information amongst members of Congress and their staff.

Suprise! Some members of Congress were arriving in Congress and becoming rich on the experience.

Ever wonder how people go to Congress and become millionaires?

The publication last year of a new academic report cleared up for us at least one way the millionaires' club known as Congress benefits.

A report from four scholars, Alan J Ziobrowski; James W Boyd, Ping Cheng; and Brigitte J. Ziobrowski, titled Abnormal Returns From the Common Stock Investments of Members of the U.S. House of Representatives,  shows that between 1985 and 2001 members of Congress enjoyed a considerable advantage over members of the public in their investment returns.

The article was published by Berkeley Electronic Press and is a follow up to a similar study done on investments by US Senators.

“A previous study suggests that U.S. Senators trade common stock with a substantial informational advantage compared to ordinary investors and even corporate insiders,” says the introduction to the report. “We apply precisely the same methods to test for abnormal returns from the common stock investments of Members of the U.S. House of Representatives. We measure abnormal returns for more than 16,000 common stock transactions made by approximately 300 House delegates from 1985 to 2001. Consistent with the study of Senatorial trading activity, we find stocks purchased by Representatives also earn significant positive abnormal returns (albeit considerably smaller returns). A portfolio that mimics the purchases of House Members beats the market by 55 basis points per month (approximately 6% annually).”

Actually 12 times .55 percent comes out to 6.6 percent annually. That 6.6 percent return accounts for an additional $130,000 over a 17 year period.   

So how lucrative can the 6.6 percent advantage be for Senators and Representatives?

A portfolio of $100,000 getting average stock market returns of 11 percent over a 17 year period would have grown to $589,000. If you were a member of the United States House of Representatives, though, enjoying the advantage that inside government information can bring you, your portfolio would have reached $1,573,000, according to an investment calculation I did using the finding from the study.

Assuming only average market returns for the next 20 years, a Representative would grow their portfolio to close to $13 million.

Under the same circumstances US Senator would have grown the portfolio to $18 million.  

The conclusion of the study favored some sort of reporting mechanism similar to those imposed upon corporate insiders, like is contemplated under the just passed STOCK Act. 

“We find strong evidence that Members of the House have some type of nonpublic information which they use for personal gain. That having been said, abnormal returns earned by Members of the House are substantially smaller than those earned by Senators during approximately the same time period. These smaller returns are due presumably to less influence and power held by the individual Members.”

While the sky won't fall if we have reporting requirements imposed on members of Congress, the report and the STOCK Act miss the most obvious point.

Why do we have a federal government that can so substantially ensure winners and losers in investments and our economy? Isn't a system like that prone to corruption? Don't we witness the effects of that corruption in legislation like Obamacare, or the cadillac benefits offered public employees?

What’s becoming increasing clear is that the government exercises too much power in the daily life of our Republic.

You can find more evidence of this in an easy-to-understand stock market phenomena that defies the typical left-right bias.   

The evidence is what’s known as the Congressional Effect.

“Specifically, since 1965, 46 years of empirical data demonstrates,” write fund manager Eric Singer, who manages a fund based on the data, “that over long periods of time the stock market performs dramatically better on days when Congress is out of session as compared to days when Congress is in session.”

Singer says that since January 1st, 1965 to December 31st, 2010 the market has returned less than one percent when Congress is in session versus a 16.57 percent return when Congress isn’t working. The numbers get worse for the last decade too. Since 2001 to the end of 2010 the market has lost 7.58 percent annualized when in session versus a gain of 12.68 percent annualized when Congress is out of session.     

I doubt very much that the STOCK Act will stop members at their staff from benefiting from inside information, however.  The example cited below with Harry Reid will still be hard to stop under the STOCK Act.  

In 2008, one month before oil prices took an historic plunge, Senator Harry Reid (D-Healthcare) sold between $15,000 and $50,000 of energy holdings he owned in the Dow Jones Energy Index. In return, he purchased between $15,000 and $50,000 worth of healthcare holdings in the Dow Jones Health Care Index at a time when he was contemplating rewriting healthcare laws. Try convincing members of the public- or anyone outside the DSCC- that the sale and purchase of these indices were just coincidental.   

The Berkeley report points out the even corporate insiders don’t enjoy the return advantages that members of Congress enjoy.

It’s one of the most damning indications yet that the scope of government has gotten wildly out of control.

It’s also another example of laws that Congress passes for the rest of us but won’t consider following. But it's a practice that must end if we want to restore confidence in government.

But even more, we can't allow our government to pass reform measures that beget more reform measures, that beget even more reform measures.   

We can only do that by making sure that government can no longer pick winners and losers in the stock market, on Main Street and in life.


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John Ransom

John Ransom is the Finance Editor for Townhall Finance.
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