Portfolios of Members of Congress *Underperform* the Wider Market

by Joshua Tucker on November 15, 2011 · 3 comments

in Legislative Politics,Political Economy

In the best spirit of The Monkey Cage, Princeton political scientist Nolan McCarty applies research by political scientists to the unfolding story of whether members of Congress have benefited from insider trading:

A recent 60 Minutes segment and a new book claim that members of Congress from both parties have benefited financially from inside information obtained in the course of their legislative duties.  Not surprisingly, the specific targets of these charges (Nancy Pelosi, John Boehner, and Spencer Bacchus) have denied doing anything illegal or unethical.

Of course, a major part of the story is that these legislators could not have done anything illegal, because there are no laws against insider trading by members of Congress.  There are vague House ethics rules against profiting financially from their official positions, but the best I can tell the House ethics process has rarely if ever been used for allegations against congressional insider trading.

Obviously, I am in no position to evaluate the specific charges highlighted on 60 Minutes or the defenses offered by the individual legislators, but there is an excellent study by Jens Hainmeuller and Andy Eggers evaluating whether or not members of Congress earn excess returns on their stock portfolios.  If insider trading were pervasive, one would expect congressional portfolios to outperform the broader market.  But this is the exact opposite of what Hainmueller and Eggers find.  In fact, legislators are generally bad investors.  Their portfolios consistently underperform.  My personal hunch is that members are often forced into weak investments for political reasons and that this works against maximizing the value of their portfolio.   Hainmueller and Eggers find one important exception to congressional underperformance.  Legislators do well with their investments in firms located in their districts.  They find, counter to the presumed effects of insider trading, that these excess returns are not due to the timing of transactions, but to the superior selection of which local firms to invest.

Of course, I can’t help wondering whether there might be a selection effect at work. I mean, if these people were better at stock trading, maybe they wouldn’t have to run for political office in the first place. Or, conversely, maybe being in Congress makes good traders into bad traders….

{ 3 comments }

RobC November 15, 2011 at 5:03 pm

Concern over insider trading by legislators seems to me overblown. What is truly objectionable, however, is that legislators allow themselves to be included on “friends and family” lists of who is permitted to purchase IPO’s at the offering price, since the practice of underpricing IPO’s means that those on the list are highly likely to realize a gain on their investment, at least if they sell quickly. The 60 Minutes report indicated that Nancy Pelosi had purchased a Visa IPO at 44, I believe, and that it was soon trading at 64. Inclusion on “friends and family” lists is a gift pretty much any way you look at it. If the legislator couldn’t accept an outright gift from a company or its executives, he or she shouldn’t be able to benefit from preferential treatment on IPO availability.

Paul Jorgensen November 15, 2011 at 7:09 pm

Before making too many definitive claims, please consult the broader literature on the topic. Perhaps there is more work to be done on this subject.
Alan J Ziobrowski and Harry McAlum. 2002. “The Real Estate Portfolio of the United States House of Representatives.” Journal of Real Estate Research, 24(1): 97-116.

Ziobrowski et al. 2004. “Abnormal Returns from the Common Stock Investments of the U.S. Senate.” Journal of Financial and Quantitative Analysis, 39 : pp 661-676.

Ziobrowski et al. 2011. “Abnormal Returns From the Common Stock Investments of Members of the U.S. House of Representatives.” Business and Politics, 13(1), Article 4.

Acilius November 16, 2011 at 11:50 am

“maybe being in Congress makes good traders into bad traders….” That’s what I would expect. Last I saw, the average member of Congress spent six hours a day raising campaign funds. Not only is that time not spent on portfolio management, it is time spent communicating with people whom the member believes to be likely to respond favorably to his or her fundraising appeals. That means that the member’s view of the market is going to be distorted, with investment opportunities associated with those people occupying a more prominent position in his or her mind relative to other opportunities. So, if you raise most of your money from the hat-pin industry, you’re going to have to strain your imagination to see past the prospects for growth in hat-pins.

Moreover, while members may not be subject to insider trading laws, they are expected to avoid conflicts of interest. So there are limits on the use to which they can put any knowledge they may gain in however many hours a day they spend doing public business. Those limits may not be as stringent as some would like, but they do put members at a disadvantage in comparison to most private citizens participating in markets.

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