Throw Them All Out

by Peter Schweizer

  Congressman John Boehner, who was leading the opposition to Obamacare in the House of Representatives, may have been fighting John Kerry on policy matters, but he was entirely allied with him when it came to investment decisions. On December 10, 2009, Boehner bought numerous health insurance company stocks, including tens of thousands of dollars in Cardinal Health, Cigna, and Wellpoint. On the same day, Boehner purchased shares in the Big Pharma companies Amgen, Johnson & Johnson, Forest Labs, Covidien, and Pfizer. He also bought shares in CareFusion, which provides systems for countering infections.23 Just days later, on December 15, the Washington Post declared that the "public option" was officially dead.24

  Health insurers breathed a sigh of relief. So too did pharmaceutical companies, who feared that a government health insurance program would lead to price controls. When Boehner bought Wellpoint stock on December 10, the price was about $56 a share. Within a month it was trading at $66 a share. Cardinal Health was up approximately 10% by the time President Obama signed the health care bill. In early 2010, Boehner bought yet more shares in Cardinal Health and Pfizer, before President Obama signed the health care bill.

  Sometimes members of Congress see an opportunity for big profits from a smaller, more obscure bill (health-related or otherwise). This approach has certain advantages. The chances of being detected are smaller, and if the focus of the bill is narrow enough, it can mean even more profits. Such was the case in the spring and early summer of 2004, as Congress debated and eventually passed something called Project Bioshield.

  Concerned about the possibility of a biological weapons attack or the prospect of a pandemic, legislators submitted a bill that called for $5 billion to be spent on vaccines that would be used in the event of a bioterrorist attack or disease outbreak. The idea behind Project Bioshield was simple: pour billions into small, specialized biotech companies that were developing vaccines and other biochemical defenses. The Department of Health and Human Services was moving forward with plans to acquire a second-generation smallpox vaccine and antidotes to other chemical, biological, and radiological weapons. The government wanted to develop, purchase, and stockpile vaccines and drugs to fight anthrax, smallpox, and other potential agents of bioterror.

  The largest financial beneficiaries of this money would be specialized biotechnology companies. The bill sailed through both houses of Congress and was signed by President Bush on July 21, 2004. But in the weeks before Bush acted, several congressmen made highly profitable "bets" on the companies that would benefit.

  Congressman Jim McDermott of Washington State bet big on one small biotech company as Project Bioshield was working its way through the House. McDermott, a member of the powerful Ways and Means Committee and a medical doctor by training, took more than 10% of his entire investment portfolio at Wells Fargo and bought shares in a small Canadian company called ID Biomedical on June 7, 2004, just weeks before he voted for the bill. The firm just happened to produce disease vaccines, exactly the kind that Project Bioshield was looking to fund. Over the next several years, the firm would do a considerable amount of business with the federal government. With the passage of Project Bioshield, ID Biomedical would secure $8 million from Washington to develop a plague vaccine.25 McDermott's timing was nearly perfect. He bought 2,000 shares at $10 a share, paying a total of $21,021, according to his brokerage statement. He sold the stock a little more than a year later, on September 21, 2005, nearly tripling his money, cashing it in for $58,837. This represents a return of 180%.26

  McDermott was not alone. Congressman Amo Houghton, Republican of New York, saw his investment portfolio mushroom with biodefense medical stocks in the weeks before Project Bioshield became law. His investment fund bought about $30,000 in Avant Immunotherapeutics (now called Celldex) on July 15, 16, 19, and 21, just days before President Bush signed the bill. The company was developing next-generation anthrax-fighting drugs and would do significant business through Project Bioshield. Houghton also gobbled up shares in Nanogen, a biomedical company, twice, on July 12 and 15. And he bought $17,355 in Northfield Labs on July 14 and another $16,792 the next day. Northfield was developing blood-replacement alternatives and would get grants from the U.S. Army through Bioshield. On July 15, Houghton bought almost $20,000 of Hollis-Eden Pharmaceuticals, which was developing disease management technologies. On the same day, he bought almost $35,000 in Maxim Pharmaceuticals, which produces antiviral drugs. The next day, July 16, he went back for more shares of Hollis-Eden, bringing his total holdings to almost $40,000.27 All of these companies would benefit from the infusion of federal dollars. If it's possible to overdose on drugs and make money from it, that is what Houghton managed to do.28

  Before he served in Congress, Houghton had a long career in corporate America as CEO of Corning and as a member of several corporate boards. If, as a corporate CEO, he had executed these trades based on insider information—concerning, say, a merger—it might have been problematic. It certainly would have received the attention of the SEC. But as a member of Congress, this sort of behavior is acceptable and commonplace.

  We despise professional athletes who bet on their own games. Why don't we feel the same way about politicians who bet on the outcome of legislation? The stakes are surely higher.

  2. CRISIS FOR ALL, OPPORTUNITY FOR SOME

  IN THE SUMMER and fall of 2008, the world economy hovered on the brink of catastrophe. A combination of too much bad debt and a burst housing market bubble threatened to push the American economy over the edge, with much of the rest of the world likely to follow. In Washington, D.C., dramatic and historic decisions involving trillions of dollars were made in rapid succession in an effort to contain the crisis. The Permanent Political Class played a central role in the drama as the government broke precedent after precedent.

  For members of Congress, the crisis meant momentous votes, long hours in closed-door meetings, and countless phone calls with federal officials. It also meant regular private consultations on both budgetary and monetary decisions. It meant private conversations with Wall Street and banking executives. It meant emergency measures, including authorizing the spending of $700 billion in taxpayer money in an attempt to create liquidity in financial markets—the Troubled Asset Relief Program, a.k.a. TARP.

  And for certain members of Congress, it also meant trading stocks at critical times.

  One of those who played a central role in governmental decisionmaking during the crisis was Congressman Spencer Bachus, then the ranking Republican on the House Financial Services Committee. (When Republicans retook control of the House of Representatives in 2010, Bachus became chairman.) It was the Financial Services Committee through which all bailout and other financial legislation had to move. When President George W. Bush discussed the passage of the Emergency Economic Stabilization Act in the midst of the crisis, he praised six members of Congress for their work on the issue, Bachus among them.1 But beyond the formal hearings on the legislation, Bachus was regularly involved in private meetings and phone conversations. As he recounted later, he "received repeated Saturday or Sunday calls announcing intervention after intervention" by the government in the financial markets.2 Henry Paulson, who was the Treasury secretary at the time, recounts in his memoir numerous closed-door meetings at which Bachus was a participant.3

  As he was having those high-level discussions, however, he was also aggressively buying and selling stock options. For his efforts, Bachus netted tens of thousands of dollars in capital gains, while most Americans watched their portfolios plummet. A lawyer and a former state senator, Bachus has served in Congress since 1993. He is not a wealthy man. According to his financial disclosure forms, his net worth is less than $1 million. But he is an active stock trader. He is particularly active when it comes to trading options, which is a relatively inexpensive way to bet that a particular stock, or the broader market, will go up or down.

  If you think a stock will fall from its current price, you can buy an option to sell it at that current price, wit
hout spending the money to own the stock itself. If the price drops from, say, $4 to $2, you can buy it at $2 and immediately exercise your right to sell it at $4. If you bet wrong, you can let your option expire without ever buying the stock. Bachus has used this investment strategy repeatedly to supplement his salary. One year, for example, he earned as much from his options trading as he did from his congressional salary. Here's the rub: all too often his trades coincided with his congressional work.

  From July 2008, when the first murmurs of the crisis were heard, to the dark days of November, with international markets in near free fall, Bachus engineered no less than forty options trades, betting that the market, a sector of the market, or an individual company would go up or down at critical times.

  Financial markets were experiencing the greatest volatility on record.4 Trillions of dollars in stock profits were being washed away. But for Bachus it was different. According to his financial disclosure statements, Bachus netted as much as $50,000 in capital gains by aggressively playing the market during this volatile period. And he netted tens of thousands more in early 2009, when financial reforms were put in place. What makes these results impressive is the fact that options trading is extremely risky. There is a rule of thumb in the financial industry that 75% of options are worthless when it comes time to redeem them, and that 80% of options traders lose money.

  In a speech he gave shortly after the financial crisis abated, Bachus noted that the political class was looking at policy and making decisions on "how the markets were reacting."5 Unfortunately, Bachus was also trading on that same information.

  In the summer heat of 2008, as the crisis was getting started and before a broader panic set in, there were concerns about the housing market and the health of banks in particular. It was not fully apparent that the entire financial system might be at risk. Some banks had failed, the investment house of Lehman Brothers had been battered but had not yet failed (it would finally go under on September 15), and government-backed Fannie Mae and Freddie Mac were in serious financial trouble. Bachus's Financial Services Committee consulted regularly with federal officials and was considering a series of legislative steps to deal with these problems.

  Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation) are congressionally chartered corporations whose original purpose was to pump cash into the nation's mortgage market. By 2007, the two had $83.2 billion in assets—but they were also carrying about $5.2 trillion in debt and guarantees. In short, they were leveraged at a ratio of about 65 to 1, and were hardly sustainable as the housing market tumbled.6 Both were deeply in trouble and effectively insolvent. If they went down, many feared that Fannie and Freddie might bring the entire financial system down with them, since it would mean widespread foreclosures on countless homes. To head off disaster, congressional leaders and administration officials conferred frequently. According to Henry Paulson's memoir, for example, a private meeting took place on September 4 in the Russell Senate Office Building, with Paulson, Senators Chris Dodd and Richard Shelby, and Congressman Bachus in attendance. During the meeting they discussed how to proceed with legislation to rescue Fannie and Freddie. There had also been congressional hearings and consultations in July and August.7

  As Bachus and his committee wrestled with these issues, the congressman was aggressively buying options.8 Back on July 14, he bought "puts"—that is, options to sell—representing the energy sector of the stock market, in the form of a sector SPDR fund. This is one among several indexed funds that track the S&P 500 corporations as divided into nine categories: consumer discretionary, consumer staples, utilities, technology, and so on. Bachus was betting that the energy sector fund would fall—in other words, the combined stock prices of energy industry firms in the S&P 500 would go down. (This is what is called selling short.) He started small, buying $4,500 worth and cashing in the next day, making close to $1,500 in capital gains.

  Ironically, on July 24, Bachus wrote to the Securities and Exchange Commission requesting that it extend an emergency order intended to curb naked short selling. Some analysts were blaming the high volatility of the crisis on speculators who made short-term bets on stock prices by shorting them. A "naked short" refers to short-selling a stock without first borrowing it, or ensuring the ability to borrow it. This is highly risky for the seller, and it greatly increases the potential amount of short selling, since anyone can do it, whether or not he can afford it, and whether or not the stock being shorted is even available. Bachus himself was not guilty of naked short selling; he was always careful to put in play small amounts of money that he could afford to lose. But naked short sellers are really just an extreme version of all short sellers, and he was actively engaged in betting on the markets to fall.

  Bachus was neck-deep in crucial financial decision-making at the highest levels. A few weeks later, he sent a letter to the Financial Accounting Standards Board, an independent private-sector organization, expressing concerns that proposed accounting changes might put at risk $10.5 trillion worth of securitized assets. Bachus wanted to see an end to mark-to-market accounting, in which an asset or liability is priced based on the current market value, and instead allow financial institutions and others to price liabilities based on the value when they are acquired.9 His position was certainly defensible, and it shows he was properly active and concerned with the state of financial markets. But he was not exactly disinterested in those markets.

  Bachus kept trading. On August 15 and August 22, he bought more than $11,000 worth of SPDR sector option contracts. A few days later, he pocketed more than $5,000 in capital gains because he "guessed" right.

  On the evening of September 18, at 7 P.M., Bachus received another private briefing for congressional leaders by Hank Paulson and Federal Reserve Bank Chairman Ben Bernanke about the current state of the economy. They sat around a long table in the office of Nancy Pelosi, then the Speaker of the House. These briefings were secretive. Often, cell phones and Blackberrys had to be surrendered outside the room to avoid leaks.10

  What Bachus and his colleagues heard behind closed doors was stunning. As Paulson recounts, "Ben [Bernanke] emphasized how the financial crisis could spill into the real economy. As stocks dropped perhaps a further 20 percent, General Motors would go bankrupt, and unemployment would rise ... if we did nothing." The members of Congress around the table were, in Paulson's words, "ashen-faced."

  Bernanke continued, "It is a matter of days before there is a meltdown in the global financial system." Bachus was among those who spoke. According to Paulson, he suggested recapitalizing the banks by buying shares.11

  The meeting broke up. The next day, September 19, Congressman Bachus bought contract options on Proshares Ultra-Short QQQ, an index fund that seeks results that are 200% of the inverse of the Nasdaq 100 index. In other words, he was shorting the market. It was an inexpensive way to bet that the market would fall. He bought options for $7,846 on a day when the Dow Jones Industrial Average opened at 8,604. A few days later, on September 23, after the market had indeed fallen, he sold the options for over $13,000 and nearly doubled his money.

  He continued in this vein, making short-term bets lasting between a day and a week, benefiting on 100-point swings. Meanwhile, the Treasury Department had worked with congressional leaders (including Bachus) to cobble together the $700 billion TARP rescue plan. The plan was publicly announced on September 22. Bachus made another options buy on Proshares Ultra on the day of the announcement. The congressman nearly doubled his money again, bringing in an additional $2,081 in capital gains.

  On September 23, the House voted against the bailout as proposed by the Treasury Department. Amendments and revisions were offered. Bachus would later be criticized by his Republican colleagues for waffling on the bill: at first he was for it, then against it, then for it again. As the bill was recast and modified, Bachus's Financial Services Committee continued with private consultations. It was not until October
3 that the revised $700 billion bailout plan passed in the House and was signed into law by President Bush. At the signing ceremony in the Rose Garden of the White House, President Bush praised Bachus's work.

  The bill gave the Treasury Department the power to purchase the toxic debt on banks' balance sheets. Paulson and others remained extremely concerned about the financial situation. Bachus was well aware of where things stood, but was apparently confident that the federal bailout would do the trick. He continued trading options, this time buying shares in an index fund known as Powershares QQQ, which tracks one hundred of the largest nonfinancial companies on the Nasdaq exchange. He bought into the fund on more than ten occasions in October, and he purchased options on the S&P 500 index six times. These were "calls"—that is, bets that the market would rise. Not all of Bachus's trades made money. These were still bets, and sometimes he bet wrong.

  On October 14, the federal government tapped into the $700 billion provided by the Emergency Economic Stabilization Act. The government took equity positions in banks that chose to participate. The next day, Bachus bought more SPDR option contracts and netted a quick $3,400. On October 21, the Federal Reserve announced it would spend $540 billion to purchase short-term debt from money market mutual funds. The next day, Bachus bought more than $5,000 worth of options in Market Vectors TRN. Thanks to his purchase of this call, he more than doubled his money.

  Bachus was not just buying options based on broad market funds or a sector of the economy. He also bought options on specific companies. On September 8, Hank Paulson received a disturbing private phone call from General Electric CEO Jeffrey Immelt. GE was having trouble selling its bonds, Immelt quietly told him.12 Just two days later, Bachus bought General Electric call options. He did so four times in a single day, according to his financial statements from Fidelity, and more than doubled his money.13 Indeed, between September 10 and 15, Bachus traded GE a total of twelve times. Nine of those trades were profitable—a huge batting average for such a risky game. Is there absolute proof that Paulson told Bachus about Immelt's phone call? No. Are Bachus's trades suspicious? You bet. Why did he bet so heavily on a company whose business is heavily in financial services?