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Highway Robbery on Capitol Hill

By Rich Smith - Updated Apr 6, 2017 at 1:15PM

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All investors are equal, but senators and representatives are more equal than others.

Salary of members of the United States Congress: $174,000.

Average annual Civil Service Retirement System benefits for retired members as of 2007: $63,696.

But the profits they can make by trading on inside information?

Priceless.

Ever since we discovered Goldman Sachs' marketing so-bad-they'll-probably-fail investments, investors have wondered whether certain players in the stock market are playing by the same rules as the rest of us. Leading the criticism of lapses in disclosure this year are, of course, our honorable people in Congress: They of the feigned outrage and pithy sound bites. But could it be that some of these politicians are just as guilty of engaging in financial shenanigans as the bankers they love to castigate?

It could be. And in fact, it is.

Something's rotten in the District of Columbia
Now, no one's ever accused the U.S. Congress of being pure as the driven snow. But every year when spring rolls around and the weather starts to warm, an especially putrid scent begins to waft down from Capitol Hill. It's the odor of malfeasance. And its source just might be your friendly neighborhood congressman.

Here's how the story unfolds: The U.S. stock market is designed to offer a level playing field, right? Everyone's free to buy and sell as they like, and ever since Regulation FD passed nearly a decade ago, everyone's supposed to do their trading based on the same information. The problem is that "everyone" apparently doesn't include members of Congress.

You may be surprised to learn this, but the laws forbidding trading on insider information -- the ones Congress passed to keep the rest of us on the straight and narrow -- generally do not apply to Congress itself. That means that lawmakers can generally trade on information they obtain by virtue of their status as guardians of the republic. They just have to report their holdings  once a year.

And what do these reports tell us, you ask? As The Wall Street Journal discovered, they show some of our elected representatives:

  • Shorting U.S. Treasuries -- through buying the ProShares UltraShort 20+ Year Treasury exchange-traded fund (NYSE: TBT) -- at the very time they were bailing out AIG, adding tens of billions of dollars to the federal debt, and weakening our national balance sheet in the process.
  • Shorting the housing market, as one congressional spouse reported buying puts on homebuilders such as Beazer and Hovnanian on at least 34 separate occasions in 2008, betting the stocks would fall.
  • Shorting the whole dang stock market, by purchasing ProShares UltraShort QQQ (NYSE: QID) -- an ETF designed to give you 2% gains for every 1% the Nasdaq declines.

Worst of all, to this Fool's eye, was congressional cynicism in the face of financial catastrophe. As TARP and other bank bailouts wended their way through Congress, the very people shaping the bills bet on their effect as they traded tens of thousands of dollars worth of stock in Wells Fargo (NYSE: WFC), Citigroup (NYSE: C), Bank of America (NYSE: BAC), and JPMorgan Chase (NYSE: JPM), according to their own financial disclosure reports.

The more things stay the same, the more they stay the same
Shameful? Certainly. But it's also lucrative. In 2004, Professor Alan Ziobrowski of Georgia State University examined the performance of more than 6,000 separate trades by members of the U.S. Senate and their relatives. His conclusion: On average and over time, senators outperformed the overall market by about 12 percentage points annually. 

Now, I certainly understand the temptation to profit from what you see happening in the future. And because members of Congress have a clearer view than most of where things are going, perched up there on Capitol Hill, the temptation must be enormous. But still, it's sad to see our elected representatives succumbing to the temptation.

Politician, legislate thyself
Sadder still, it didn't have to be this way. Four years ago, Representatives Brian Baird of Washington and Louise Slaughter of New York tried to pass a law that would change the rules, remove the temptation, and subject Congress to the same restraints it imposes on the rest of us. The "Stop Trading on Congressional Knowledge Act," better known as the STOCK Act, would forbid lawmakers from trading on nonpublic information. And just to be safe, when they did trade, they'd have to disclose trades publicly within 90 days of settlement.

The problem is that these ideas weren't particularly popular with the politicians' peers. Only 14 representatives signed on to the proposed legislation when it was introduced. Four years later, this year's version of the bill has attracted six signatures. And support in the Senate? That would be precisely nil.

Titanic hypocrisy, and ...
Words fail me as I struggle to describe my outrage at learning these facts. Titanic hypocrisy sounds too tame. "A betrayal of public trust of truly epic proportions" barely scrapes the surface. But however you choose to describe it, one thing is clear: This must not stand.

A modest proposal
We've said for years here at the Fool that investing in the stock market is the best way to build individual wealth. I would not deny members of Congress that privilege, just because they choose to pursue public service for the modest sum of $174,000 per year plus pensions in perpetuity. But even the STOCK Act doesn't go far enough. Although most members of Congress balk at the modest requirement of disclosing their trades once per quarter, that doesn't come close to what we should demand of them.

In my humble, Foolish view, members of Congress should take a page from what we do here at the Fool. Rather than disclose their stock trades once per year, or even once per quarter, after the fact, they should do what our real-money portfolio services do: Announce their intent to trade beforehand. Make it public. Reveal their cards before playing them. I think that's financial disclosure that even Caesar's wife could support.

Editor's note: A previous version of this article said that the transactions related to homebuilders were put sales rather than put purchases. The Fool regrets the error.

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Stocks Mentioned

Citigroup Inc. Stock Quote
Citigroup Inc.
C
$49.75 (-0.06%) $0.03
Bank of America Corporation Stock Quote
Bank of America Corporation
BAC
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JPMorgan Chase & Co. Stock Quote
JPMorgan Chase & Co.
JPM
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Wells Fargo & Company Stock Quote
Wells Fargo & Company
WFC
$41.67 (-0.79%) $0.33
ProShares Trust - ProShares UltraShort QQQ Stock Quote
ProShares Trust - ProShares UltraShort QQQ
QID
$25.80 (0.62%) $0.16

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