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P$ychic Senators
Bill Frist isn't the only senator to have demonstrated "uncanny investing smarts," as James Surowiecki wryly put it in the October 31 New Yorker. Look how well some of the rest of the scumbags, uh, senators, have been doing in the market:

Last year, Alan Ziobrowski, a professor at Georgia State, headed the first-ever systematic study of politicians as investors. Ziobrowski and his colleagues looked at six thousand stock transactions made by senators between 1993 and 1998. Over that time, senators beat the market, on average, by twelve per cent annually. Since a mutual-fund manager who beats the market by two or three per cent a year is considered a genius, the politicians’ ability to foresee the future seems practically divine. They did an especially good job of picking up stocks at just the right time; their buys were typically flat before they bought them, but beat the market by thirty per cent, on average, in the year after. By those standards, Frist actually looks like a bit of a piker.

Are senators really that smart? The authors of the study suggest a more likely explanation: at least some senators must have been trading “based on information that is unavailable to the public”—in other words, they were engaged in some form of insider trading. It’s impossible to pin down exactly how it happened, but it’s easy to imagine senators getting occasional stock tips from corporate supplicants, and their own work in Congress often deals with confidential matters that have a direct impact on particular companies.

That the senators have done this without a hint of censure shouldn’t come as a surprise. Corporate insider trading is illegal, in theory, but prosecutions are rare. Economists have known for a long time that corporate insiders outperform the market by something like six or seven per cent a year. The only way they could pull that off is by trading on privileged information. And some people think that’s as it should be. Beginning in the nineteen-sixties, when Henry Manne published “Insider Trading and the Stock Market,” many theorists have argued that insider trading is a victimless offense, or even a positive good. After all, some investors always have better information than others, and if a well-informed trader didn’t have the incentive of trading on what he knew the stock market would dry up. Furthermore, since insider trading is, by definition, based on accurate information, it moves stock prices in the right direction. Isn’t this just market efficiency in action?

Not really. Ultimately, insider trading is an inefficient way of achieving market efficiency, because insiders earn all their profits on the lag between when they start selling and when the market figures out what’s going on. This gives them every reason to hoard information, with the result that stock prices are out of whack for longer than they otherwise would have been. Markets thrive on transparency, but insider trading thrives on opacity.

Insider trading therefore encourages executives to put their own interests before those of their shareholders. In fact, the real scandal of insider trading is not what’s illegal but what’s legal. For instance, although many companies have a rule that their employees can buy or sell company stock only during preordained periods, known as “trading windows,” they don’t need to announce in advance if they’re going to buy or sell during a window. So executives who get bad news can still dump shares relatively freely (or, if they get wind of good news, buy freely). They also have an incentive to delay disclosing news until after they’ve bought or sold all they can. Alan Jagolinzer, an accounting professor at Stanford, has shown that the stocks sold by insiders tend to drop after the sales go through, and a Financial Times study of the twenty-five biggest bankruptcies in the wake of the stock-market crash found that executives and directors in those firms collectively unloaded almost three billion dollars of stock even as their companies headed to oblivion. (The corporate insiders at H.C.A. managed, perhaps quite legally, to dump more than a hundred million dollars in H.C.A. stock in the six months before it cratered.)

Posted by aalkon at January 11, 2006 7:42 AM

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Comments

So, what you and your quoted author seem to be saying, is that Frist (and other senators) are fully qualified to run for president. After all, what the last 30 or so years appear to demonstrate is that you need to be rich and crooked to be the "leader of the free world." (now I remove tongue from cheek.)

Posted by: Michael at January 11, 2006 8:46 PM

Hey - your car mechanic gets a break on cars, car parts and service. People of a trade deal more easily with their peers because there aren't any lengthy explanations to curb stupidity.

Posted by: Radwaste at January 14, 2006 11:50 PM

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