Throw Them All Out

by Peter Schweizer

  This was not the only instance when Bachus took leveraged stock options that were intertwined with his government work. Back in 1997, he aggressively purchased eleven put options on United Airlines, betting on the stock to fall. At the time, Bachus was on the House Transportation and Infrastructure Committee, which set policy toward the airlines. That same year, Bachus also took short positions in Microsoft. The Department of Justice was in the midst of its antitrust case against the company. Bachus purchased two puts just days before the Justice Department filed a complaint demanding a $1-million-per-day fine against Microsoft for its violation of a consent decree. Is there proof that he knew about the complaint? No. But the larger pattern is suspicious. In the middle of the antitrust hearings he placed more bets that Microsoft stock would fall. On the Microsoft transactions he netted up to $20,000 in capital gains, according to his financial disclosure form.

  Bachus has been able to use his above-average success with option trades to yield a nice supplemental income. In 2007, the congressman undertook several dozen risky short-term put and call options on a variety of companies. He was betting that he would know whether a company's price would go up or down. These included companies like Apple as well as obscure Chinese Internet advertising companies like Focus Media. Bachus had impeccable timing. In over two dozen cases, representing more than two-thirds of all the trades he made, he guessed correctly.

  In the case of Focus Media, for example, he held the investment for only two weeks, and sold it on the same day that the company's stock price surged following its announcement that it would acquire a competitor. Again, there is no proof that he knew of the acquisition in advance. But it is highly unlikely that his two-thirds success rate in those 2007 trades could have been based on public information alone. If so, he should have quit Congress and become a professional investor. All told, in 2007 Bachus was able to supplement his $165,200 congressional salary with $160,000 in profits from aggressive put and call options on a variety of stocks.14

  A spokesman for Bachus, Jeff Emerson, claims that this presented no difficulty. "There is no conflict of interest," he says. "He asked the Ethics Committee if he could do this, and they said there's no problem." As a matter of law, that answer is accurate and complete. Only Congress's own Ethics Committee can decide whether to condone this kind of stock trading.

  Here's the heart of the scandal—the fact that the Ethics Committee deems this acceptable. Welcome to the outrageous arrogance of crony capitalism in Washington. Not only are members of Congress able to act on information that is not available to the rest of us, but they are able to put their own fortunes at risk when they ought to be concerned only with the public interest. If you bet on a particular sector of the economy to fall over the course of a few days or weeks, how can you be sure that your subsequent decisions are not influenced by that bet?

  Congressman Bachus was not the only one actively trading stocks while setting policy during the financial crisis. But he was particularly aggressive with options; others merely cashed out of positions that were just about to worsen. Sometimes knowing inside information can mean protecting your assets while the rest of America goes over a financial cliff.

  On Tuesday, September 16, 2008, when Henry Paulson and Fed Chairman Ben Bernanke held another of their terrifying closed-door meetings with congressional leaders (two days before the "ashen-faced" meeting), the stock market had dipped only a few percentage points, and most people assumed that the financial crisis was a disruption that would have just a limited effect on the broader economy. But what Paulson and Bernanke told lawmakers on September 16 made it clear that the public's perception was wrong. Paulson, in his memoir, explains that during the meeting he outlined that the federal government was going to bail out the insurance giant AIG and that the markets were in deep trouble. "There was an almost surreal quality to the meeting," he recounts. "The stunned lawmakers looked at us as if not quite believing what they were hearing."15

  The next day, Congressman Jim Moran, Democrat of Virginia, a member of the Appropriations Committee, dumped his shares in ninety different companies.16 Moran is a former mayor and city councilman of Alexandria, Virginia. Earlier in his political career he had faced legal charges for casting a vote on the Alexandria City Council that helped a developer friend win a bid for a lucrative plot of land. Moran pleaded no contest to a misdemeanor charge and resigned. It did not stop his career. He was elected mayor in 1985, and to Congress shortly after. (It's interesting to note that legal standards in Virginia are apparently higher than those of the U.S. Congress. Had Moran cast that same vote in Congress, there would be no cause for any charges!)

  September 17, 2008, was by far Moran's most active trading day of the year. He dumped shares in Goldman Sachs, General Dynamics, Franklin Resources, Flowserve Corporation, Ecolabs, Edison International, Electronic Arts, DirecTV, Conoco, Procter & Gamble, AT&T, Apple, CVS, Cisco, Chubb, and a dozen more companies. Moran's timing was impeccable. He didn't profit very much from these trades, but he avoided the larger losses that the general public would face in a matter of weeks. Moran and his wife actually eked out a net capital gain on these trades.

  Moran was just one of many. At least ten U.S. senators, including John Kerry, Sheldon Whitehouse, and Dick Durbin, traded stock or mutual funds related to the financial industry the following day. Representative Shelley Capito is a Republican from West Virginia who sits with Congressman Bachus on the House Financial Services Committee. She and her husband dumped between $100,000 and $250,000 in Citigroup stock the day after the briefing. According to her financial disclosures, she and her husband somehow managed to accrue capital gains from Citigroup stock transactions made throughout the crisis, as much as $50,000 worth.17

  Senator Dick Durbin, the Democratic whip and chairman of the Subcommittee on Financial Services and General Government of the Senate Appropriations Committee, attended that September 16 briefing with Paulson and Bernanke. He sold off $73,715 in stock funds the next day. Following the next terrifying closed-door briefing, on September 18, he dumped another $42,000 in stock.18By doing so, Durbin joined some colleagues in saving themselves from the sizable losses that less connected investors would experience. The stock market collapsed shortly after these congressional trades. By October 3, just seventeen days after the September 18 meeting, the market had dropped more than 9%. A month later, it had plummeted over 22%. Preventing a catastrophic loss can be just as important as making a big gain.

  Senator Durbin did not just sell stocks based on his inside knowledge. Like Bachus, he was looking for opportunities to invest. Though he sold many of his holdings, he also bought tens of thousands of dollars' worth of Berkshire Hathaway, the holding company run by the legendary investor Warren Buffett. Durbin bought shares on September 19 and 22—more than $60,000 worth. His timing was nearly perfect. The next day, September 23, it was announced that Berkshire Hathaway was buying part of Goldman Sachs, which would yield a 10% guaranteed dividend for Berkshire investors like Durbin. The deal had been discussed behind closed doors for days before Buffett announced it publicly. Durbin's spokesman insists that the senator "didn't use any information from that closed-door gathering to counsel his trades the following day." Yet it is almost certain that Durbin, as chairman of a crucial subcommittee, knew about the Goldman Sachs deal.

  When the House Financial Services Committee was crafting legislation for the TARP bailout of banks in the fall of 2008, eight members of the committee were actively and aggressively trading bank stocks. So too were members of the Senate Finance Committee. As the Treasury Department was conferring over which banks would get the bailout money, Senator John Kerry started buying Citigroup stock. The markets might have been down and in turmoil, but Kerry was buying the troubled company. Lots of it. He purchased up to $550,000 in Citigroup stock in early and mid-October. He also bought up to $350,000 in Bank of America shares. Days later, on October 28, it was announced that Citigroup was getting $25 billion from the TARP Capital Purchase Prog
ram and another $25 billion from the Targeted Investment Program. On November 4, it was announced that Citi would be provided additional loan guarantees that could total $277 billion, from the Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation.19

  Members of Congress are privy to all sorts of inside information about pending government actions. Some of it comes from their actual actions—that is, passing legislation. Some of it comes as a result of their position of power. Legislators are told things by regulators or bureaucrats in private because they ask about them. While a committee's public hearings are generally about stagecraft, very frank and detailed conversations often take place behind closed doors. The most valuable information is revealed in private meetings, phone calls, and correspondence. If members of Congress buy and trade stock based on that information, or if they pass that information along to a campaign contributor or their own financial advisers, they are not considered guilty of any wrongdoing. Yes, this is an outrageous standard. But remember, they write their own rules.

  Consider for a moment the fact that the political class regularly trades stock in government-backed entities like Fannie Mae and Freddie Mac while at the same time determining the fate of those very entities.

  Fannie and Freddie were chartered by Congress, and both have implied government guarantees. For many years, these entities were exempt from the nation's financial disclosure regulations—and politicians traded shares in these companies. Indeed, Fannie and Freddie were even exempt from insider trading rules. And in this murky world, Senate and House members invested with one hand while they exercised oversight with the other.

  In February 2003, Rahm Emanuel was a newly elected member of Congress from Chicago. He had a seat on the House Financial Services Committee's Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises, which had direct supervision over Fannie and Freddie. Emanuel had previously served on the Freddie Mac board—he'd been appointed by President Clinton in 2000—so he was very familiar with its inner workings. On February 21, Emanuel suddenly sold off all of his Freddie Mac stock, up to $250,000 worth.20 He did so just days before a nearly 10% drop in the share price. It was not until the late spring that the public learned in full what was going on at Freddie Mac: there was a criminal investigation of its senior executives, and its earnings had been inflated and would need to be restated to the tune of billions of dollars. (The Freddie Mac accounting scandal was actually larger than that of Enron.)

  Were a board member or employee with intimate knowledge of a corporation to dump all of his shares right before an announcement of bad news and a plunge in the stock price, it would at least warrant a look by the SEC. But when a member of Congress does the same thing, he gets a free pass.

  The profitability and stock price of Fannie and Freddie have been closely tied to the politics of Washington. On Election Day 2004, when exit polls initially—and wrongly, as it turned out—suggested that John Kerry would win the presidency, Fannie Mae stock markedly rose. When it became clear on November 3 that President Bush had been reelected, Fannie stock opened down and fell sharply for the day, while financial stocks gained overall.21 The reason is simple: George W. Bush was seen as a likely proponent of reforming the government-backed financial giant, whereas Senator Kerry was an opponent of such reforms.

  WE KNOW WHAT'S HAPPENING BEFORE YOU DO

  There is nothing wrong or unusual about that stock movement, nor anything surprising about the positions taken by Bush and Kerry on the issue. But were those positions influenced by self-interest? For years, Kerry had been an advocate for expanding Fannie Mae's mission, not reforming it.22 He was generally opposed to removing any government guarantees, tightening lending standards, or greater regulatory oversight by Congress. As Kerry was resisting legislative efforts to impose additional regulatory restrictions on the financial giant, he and his wife were quietly selling off their extensive Fannie Mae holdings throughout early 2005.23 Indeed, over a six-month period they dumped around $1 million in Fannie Mae stock. (Again, only ranges were disclosed, not actual figures.) Furthermore, the Kerrys were trading their shares at the same time that the company was telling all of its employees that they could not trade the stock until the new earning results were made public.24 The Kerrys, who had traded Fannie Mae shares for years, dumped the stock before it suffered serious declines. They actually managed to post capital gains on the stock of up to $250,000 on those transactions.25 How many other Fannie Mae investors could claim that, in what was a bad time for the stock?

  Members of Congress sometimes pay lip service to avoiding potential conflicts of interest. Indeed—and ironically—in 2009, when the federal government was passing out hundreds of billions of dollars in TARP funds to private financial institutions, Speaker of the House Nancy Pelosi argued that "when there's been a thought of conflict of interest" between a member's financial holdings and government bailouts, then that member "should divest."26

  But there is simply no evidence that Pelosi, or any other member, did so. And there is no evidence of any member of Congress recusing himself when it came to voting on matters that would directly benefit him.

  They bet on their own games. They bet on failure. Is there any solid evidence that their political decisions were tied to these bets?

  For that, you have to look at some very narrow, tailored bets. Sometimes legislators receive big financial favors from specific companies—and then they work to help those firms.

  3. IPOs: INVEST IN POLITICIANS OFTEN

  IF YOU COME into Congress already rich, serving there will give you an opportunity to become even richer.

  In early 2008, Speaker of the House Nancy Pelosi and her husband, Paul, placed a very big bet. On March 18, the Pelosis made the first of three purchases of Visa stock, totaling between $1 million and $5 million.1 But this was no ordinary stock transaction. Somehow the Pelosis managed to get their hands on shares of what would become one of the most popular and lucrative initial public offerings of stock in American history. An IPO, as the name implies, is the first stock offering made by a company prior to its going public. Visa had been privately held by a group of banks up until that year.

  Mere mortals would have to wait until March 19, when the stock would be publicly traded, to get their shares. According to the Pelosis' financial disclosures, two of their purchases were made after the nineteenth, but one was made before. They listed all three purchases together on their disclosure statement, making it impossible to know how many shares they purchased in the initial offering.

  In any event, getting access to this IPO was virtually impossible for the average individual investor. MarketWatch and other news organizations reported that the IPO was "oversubscribed." In the words of IPO analyst Scott Sweet, it was drawing "extreme demand." Virtually all of the Visa IPO shares were going to institutional investors, or large mutual funds or pension funds. Renaissance Capital declared the offering to be the "IPO of the year."2 Who got these coveted shares? Only "special customers," hand-picked investors, received the IPO shares at the opening price of $44. Two days later, after public trading began, the stock price jumped to $65 a share. In short, the Pelosis made a 50% profit on their investment in a matter of two days. They liked the stock so much, they made another purchase, on March 25. On June 4, 2008, they made a third purchase—and Visa stock closed at $85 a share.

  What makes this all the more remarkable is that this single investment represented at least 10% of the Pelosis' stock portfolio and potentially as much as half of their equity holdings (depending on where in the range of $1 million to $5 million it actually fell). They were staking a good part of their fortune on one company. How unusual was this for the Pelosis? Although rich in real estate, according to their financial disclosure form, they had only once before committed more than $1 million of their assets to a large, publicly traded corporation: Apple Computer.

  It was an enormous risk. Or was it?

  The Speaker of the House and her husband jus
t happened to get those IPO shares barely two weeks after a threatening piece of legislation for Visa was introduced in the House of Representatives. John Conyers, chairman of the House Judiciary Committee and an old liberal warhorse, was joined by conservative Republicans Chris Cannon of Utah and Steve King of Iowa, among others, in introducing the Credit Card Fair Fee Act of 2008. The bill had forty-five sponsors in all. It would effectively allow retailers to negotiate lower fees with Visa and the other credit card companies. Retailers argued that these companies—American Express, Visa, MasterCard, and Discover—often set fees together, like a cartel.

  By way of background, it's important to understand that Visa does not issue credit cards or make loans; banks do. Visa makes its money by licensing the Visa name and through something called an interchange fee. Every time you use a card at a store, the merchant pays Visa an interchange fee, somewhere between 1% and 3%. Merchants argued that Visa, MasterCard, American Express, and Discover should not be able to keep their fees so high. The Credit Card Fair Fee Act would have amended antitrust laws to require the card companies to enter negotiations with merchants over their interchange fees, and if they could not agree on fees, the Justice Department and the Federal Trade Commission would be empowered to arbitrate. These fees are a huge source of revenue for Visa and the other credit card companies, and a constant thorn in the side of merchants. In 2008, the four companies took in $48 billion in revenue, or about $427 per household, from interchange fees.3