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Andrew Eggers and Jens Hainmueller

Do members of Congress use insider information?

THE PAST few weeks have witnessed an uproar over investing practices in Congress following the publication of a new book that alleges members of Congress enrich themselves by engaging in a kind of insider trading that would be illegal for the rest of us. The allegations, by Peter Schweizer in “Throw Them All Out,’’ have struck a nerve with citizens who are upset that Washington insiders may have personally profited from the kind of financial shenanigans that they collectively failed to police.

In response, Senator Scott Brown of Massachusetts has sponsored legislation to restrict political "insider trading," and similar legislation has attracted dozens of new co-sponsors in the House. We think the proposed restrictions are appropriate, just as it is important to ask members of Congress to explain their investment decisions.

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But it is also important to understand what is being overlooked in the uproar. Our own analysis of congressional investment portfolios suggests that Congress’s critics are greatly overstating the extent to which politicians profit from their investing activities.

Schweizer’s analysis is based on well-timed stock trades found in congressional financial disclosure forms. We analyzed the same data, but instead of cherry-picking suspiciously well-timed trades, we recreated the entire stock portfolio of each member and conducted a systematic financial analysis of their performance as investors.

We found that members of Congress generally perform no better than ordinary investors. Over the 2004-2008 period, the stock portfolio of the average member of Congress underperformed the market by 2 to 3 percent per year. Put another way, in a five-year period during which the market lost around 20 percent of its value, the average congressional portfolio lost over 30 percent. Even individuals whom Schweizer singles out for suspicious trades would probably have been financially better off if they had replaced their stock portfolios with a passive index fund.

What does this mean for the uproar over congressional insider trading? We see three main lessons:

First, the public should be somewhat reassured to know that members of Congress are not systematically enriching themselves through savvy investments. Our finding that members of Congress actually receive only average returns does not imply that congressional investing behavior is ethical, nor does it suggest that current legislation is sufficient to regulate that behavior. But it does suggest that we should be wary of claims that Congress is full of crooks who are using their political power to get rich.

Second, powerful anecdotes do not always tell the whole story. The current uproar is fueled largely by a few examples of members of Congress executing profitable trades at moments when they had access to political “inside information.’’ For example, Schweitzer mentions that Senator John Kerry made money trading health care stocks while his subcommittee was considering health care legislation. What the book doesn’t mention is that Kerry’s money managers traded stocks constantly (over 3,000 stock trades in the 2004-2008 period), and that they lost just as often as they won. It’s not a very impressive performance for his money managers, but it does suggest that we should be suspicious of cherry-picked trades as evidence of corruption.

Third, it is hard to see any reason why members of Congress should oppose legislation limiting their ability to play the stock market while in office. Political insiders face clear temptations to profit from their privileged information; regardless of whether they successfully indulge in those temptations, citizens will suspect them of doing so. We support legislation that goes beyond what is currently being considered in Congress and requires members to put their assets in blind trusts or broad index funds. Such a regulation should help protect members of Congress from suspicion of unethical behavior.

Perhaps some members of Congress have resisted limits on their investing activity because of the belief that they financially benefit from dabbling in the market. We would be happy to provide them with a free consultation on their investment performance; they should be prepared for disappointment.

Andrew Eggers is a lecturer at the London School of Economics. Jens Hainmueller is an assistant professor at MIT.
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