Economics, U.S. Economy

Huge ‘capitol gains’ for Congress from a substantial informational advantage

When in comes to insider trading, members of Congress operate above the law and they can legally buy and sell stocks using the substantial nonpublic, informational advantages they have over the general public and even over corporate insiders. The congressional exemption from insider trading laws that apply to the rest of us has been receiving some well-deserved attention in Peter Schweizer’s forthcoming book Throw Them All Out: How Politicians and Their Friends Get Rich off Insider Stock Tips, Land Deals, and Cronyism That Would Send the Rest of Us to Prison. Schweizer was featured on a “60 Minutes” segment last Sunday and AEI’s Marc Thiessen provides details and commentary in his recent Washington Post column “Crony Capitalism Exposed.”

Just how valuable is the inside information that members of Congress have when it’s used for personal trading? Very valuable, according to a 2011 research article in the academic journal Business and Politics titled “Abnormal Returns From the Common Stock Investments of Members of the U.S. House of Representatives.” Four researchers analyzed more than 16,000 common stock transactions between 1985 and 2001 that were executed by 300 members of the House. The empirical evidence showed that the personal stock portfolios of the 300 House members outperformed the overall stock market by 55 basis points per month on average, or by 6.6 percent on an annual basis.

The chart above illustrates how an additional excess return of 6.6 percent per year for House members would have affected an investment in stocks during the years of the study. A hypothetical $1,000 investment in the S&P500 Index at the beginning of 1985 would have grown to $6,043 by the end of 2001, earning an annual return of 11.16 percent in the broad stock market. In contrast, adding a 6.6 percent annual premium for lawmakers due to their informational advantage over the public would have generated an annual return of 17.76 percent, and the $1,000 investment would have grown to $16,172 in 2001, or $10,000 more than the investment in the overall stock market represented by the S&P500 Index. In other words, for each $1,000 invested over the entire 1985-2001 period, the informational advantage of House members could have earned them an additional $10,000 compared to the increase in the overall stock market during that time.

Bottom Line: The empirical evidence in this study from an earlier period confirms much of what Schweizer has uncovered more recently: that members of Congress have access to valuable inside information that is not available to the public or even corporate insiders, many members successfully use that information to their advantage when trading stocks in their personal portfolios, and that information allows them to generate huge excess returns or what maybe should be called very generous “capitol gains.”

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