Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

A Congressional Insider Trading ETF?

US Capitol Building with cash

This is one creative solution to congressional insider trading: Allow investors to buy an exchange-traded fund that tracks congressional investments.

The idea comes from John McDermott at FT Alphaville.

"When President Obama was selling his health-care plan, he often said that ordinary Americans should get the health-care available to those in Congress. Extending this logic suggests that U.S. 401(k)s should be able to invest in what we’re calling The Keep America Safe Job-Creating Congress ETF, a fund that tracks the investments of this nation’s lawmakers," McDermott writes.

For this to work, of course, it would have to trade in real time right alongside the lawmakers. Perhaps we could require lawmakers to preemptively disclose all trades to the ETF managers, with enough lead to to allow the ETF to execute the trades simultaneously with the lawmakers.

The biggest problem with this suggestion is that, as a whole, congressional trading has actually gotten a lot worse. Although members of Congress used to regularly be able to outperform the market, lately they have fallen behind.

Meghan McArdle at The Atlantic explains:

A few years ago, after the Center for Responsive Politics made congressional disclosure forms available in an easily searchable data set, two graduate students in Harvard’s political-science department decided to revisit the question for the new millennium. Andrew Eggers and Jens Hainmueller, now assistant professors at the London School of Economics and MIT, respectively, had become interested in the emerging literature on whether politicians benefit financially from holding office, and they were just finishing their first paper, which used probate data to look at that question in the United Kingdom. (Answer: Yes, at least if they were Tories in the House of Commons between 1950 and 1970.)

They eagerly attacked the U.S. data. Both of them got a big surprise. Their data, which covered 2004 through 2008, didn’t show Congress outperforming the market by 12 percent. In fact, they didn’t show it outperforming the market at all. For the five years they studied, Congress actually underperformed the market by 2 to 3 percent annually. On average, Congress did worse than an index fund, and about as well as your average stock-picking granny. If Congress was indeed trading on inside information in the late 1990s, it seemed to have stopped.

No one knows exactly why congressional traders have been underperforming lately. My favorite idea is that the earlier studies that showed congressional outperformance attracted hedge funds and investment bank traders into the business of obtaining non-public political information. Several firms sprung up to sell information about Capitol Hill events. Lobbying firms began doing a side business briefing traders on conversations with lawmakers and staffers. This increased the number of market participants trading on the information, making the information less valuable for trading.

There are several other possibilities. One that McArdle raises is that the structure of the market may have changed with the introduction of high-frequency traders and other quants. Prices are now more efficient than ever, making it harder to employ asymmetrical informational advantages. Another is that Congress has been scared straight by the publicity this issue has been getting.

A year and a month ago, I raised a few other possibilities:

  • Legislation over the period in question may have been less effective at moving share prices;
  • Information provided to lawmakers may be less reliable as a guide to the stock performance of companies involved; and
  • It's possible that the financial acumen of lawmakers has declined, making them less able to translate their non-public information into tradable ideas.

One question might be whether it matters which party holds the majority in Congress. Democrats are better traders than Republicans, which might be a result of Democrats favoring a more activist approach to government. This, in turn, could create more trading opportunities for those possessed of insider political knowledge.

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