Throw Them All Out (21 page)

Researchers who have studied politicians and bureaucrats who retired and then joined corporate boards have found that government officials usually accept board seats within a month or two of leaving office. However, when a former government official's political party is out of power, "he or she [is] significantly less likely to gain a board appointment." In other words, this is about access, not about experience.
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James Kristie, editor of the
Directors and Boards Journal
(yes, there is such a thing), says that ex-politicians on corporate boards are "very prevalent." What they offer is "knowledge of how government works, and access to a high-level network of leadership structure that many of the other board members do not." Sarah Teslik, executive director of the Council of Institutional Investors, notes that former politicians "have not brought any particular expertise that we can measure from the outside." She also finds that they are less likely to speak up at corporate board meetings and less likely to challenge CEOs than other directors.
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Ideally, the economy should be based on competition—companies competing for customers. But for many companies the "customer" that matters most is the government, and competing in Washington means political connections and access. The integrity of our markets is threatened when political influence trumps sound financial decisionmaking, and that is precisely what we face. A study that looked at the political connections of board members of S&P 500 companies found that the price of a stock rose an unusual amount following the announcement of the nomination of a politically connected individual to any given board of directors. In response to the Republican win in the 2000 presidential election, companies with connections to the Republican Party increased in value, and companies connected to the Democratic Party decreased in value.
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Another study by academics found that in the United States when powerful political figures died, companies to which they had strong connections saw their stock prices drop an average of 6% on news of their passing.

Journalist Ira Stoll conducted a more recent exercise centered around the first couple of years of the Obama presidency. He investigated the stock prices of corporations closely aligned with the administration—those whose CEOs were frequent guests at White House dinners or served on advisory boards. Was this hobnobbing a smart financial move? Did those connections help? Stoll writes:

 

So I spent some time running the numbers. Suppose one began this strategy at the beginning of the Obama administration, buying one share of each publicly traded company with an executive appointed by the president on February 6, 2009 to the President's Economic Recovery Advisory Board. That would be UBS, GE, CAT, and ORCL. In the nearly two years since then (using the Monday February 7 closing prices, and using Yahoo! Finance historical price data that adjusts for splits and dividends), the gain would have been 145%—far outperforming the 52% return of the S&P 500 Index over the same period.

Suppose that later that year, you decided to buy one share of each American publicly traded company that had a top executive attend President Obama's first state dinner at the White House, in honor of Prime Minister Singh of India. GE and CAT are on the list again, along with Honeywell, Pepsi (CEO Indra Nooyi) and Ethan Allen CEO Farooq Kathwari. The return through day's end February 7, 2011 would have been 46%, versus a 19% gain for the S&P 500 over the same period.

Or suppose you wanted to invest in the publicly traded companies whose executives President Obama appointed on July 7, 2010 to the President's Export Council. Buying UPS, Boeing, Met Life, Disney, Pfizer, Dow Chemical, Ford, Verizon, United Airlines, ADM, and Xerox would have earned a 30% return over a period in which the S&P 500 gained 24%.
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There were exceptions, Stoll points out. Morgan Stanley, Bank of America, and UBS have underperformed the market. And Stoll's work has not undergone academic review (although I ran the numbers myself and came up with the same results). It could be a coincidence. It could be that President Obama surrounds himself with CEOs who help their firms consistently beat the market. But as we've seen, there is a body of research that shows this pattern has existed for quite some time. At what point do anecdotes start sounding more like epidemiology? When are coincidences so consistently aligned they appear to be predictable money trails?

 

It's no coincidence that the realm of crony capitalism is populated by billionaire financiers and large corporations. As the economist Will Wilkinson puts it, "The more power the government has to pick winners and losers, the more power rich people will have relative to poor people." And crony capitalism is the ultimate system of wealth redistribution: poor and middle-class taxpayers subsidize the superrich. Call it trickle-up economics.

It is the nature of crony capitalism to expand. Politicians want more campaign money and personal wealth, so they leverage their position and hand out favors. Corporations and financiers need those favors to get ahead, so they flock to Washington. If you can get early access to market-moving information, if you can secure government grants or subsidies or loans, if you can create regulation roadblocks for your competitors, why not? It is probably more cost-effective than developing a new product or service.

Crony capitalism also breeds inefficiency and confusion, blurring lines between the public and private sectors. The more complex the laws, the better it is for the Permanent Political Class and crony capitalists. A bloated bill of two thousand pages makes it easier to insert and hide things. For example, the massive health care reform bill included a provision, section 2711, that made it possible for certain entities to obtain waivers from the law. Did anyone outside the crony system understand the implications of that provision? The secretary of the Department of Health and Human Services has granted more than a thousand waivers under section 2711. Many of these have gone to President Obama's political allies: labor unions and connected companies.

Had the health care bill been twelve pages long, it would have been a lot more difficult to hide the subject of waivers. Furthermore, a massive bill means more people hire lobbyists and experts to help them navigate it when it becomes a complex new law. A couple of years ago,
National Journal
analyzed the number of family members of sitting senators who were working as lobbyists. Fully thirty-three senators had family members who were registered as lobbyists or who worked for lobbying firms.
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That's one-third of the United States Senate.

As Senator Tom Coburn of Oklahoma has put it: "Many legislators and their staffs have children or spouses who are or have been employed as lobbyists including many of the most powerful members and leaders of the Senate. Yet, no rules or laws currently prevent lawmakers or their staffs from being lobbied by relatives. Neither lawmakers nor lobbyists must report if they are related to each other."
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Add to the list of laws and regulations that don't apply to Congress: rules against nepotism.

Dennis Hastert has a son who had been managing a record store in Illinois before Representative Hastert became Speaker of the House Hastert. When his father took the gavel, the son became a well-paid lobbyist in Washington. Senator Trent Lott's son, who was managing Domino's Pizza franchises before going to Washington, also made great money by becoming a lobbyist on the side.
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The rule of law, and the notion that no one is above the law, is fundamental to a healthy democracy. If we accept crony capitalism with a shrug and an eye roll, we might as well accept a world of bribery and out-and-out vote buying. Crony capitalism has a corrosive effect on our politics, our economy, and our character. And we don't have to accept it. It's one thing to say that our country was founded on the Constitution—as in "back then." It is another thing entirely to grasp that the Constitution is a living contract, rooted in legal soil that makes it wrong for politicians to serve themselves and their cronies. It is high time we did some weeding.

The longer they live, the bigger babies they are.

—
PROFESSOR WILLIAM GRAHAM SUMNER
of Yale, 1895, on the demands of businessmen and politicians for special privileges

 

L
ET'S BE CLEAR:
we need to stop coddling these people. Many others have been prosecuted for actions much less serious than those discussed in this book.

These people are not doing us a favor, and they don't deserve special treatment. There is no reason why only one place in the United States should be excluded from ethical standards and laws concerning insider trading, conflict of interest, nepotism, and cronyism. That in that same place, you won't be protected if you report financial corruption. After all, that may be the one place where we most need all these things: Washington, D.C.

The problem with Washington isn't gridlock. It isn't that things aren't getting done. The problem is the corruption of the public spirit. The Permanent Political Class has no sense of urgency to change because, for them, business is good.

We need to break the cycle of crony capitalism, land deals, and insider trading. And we can do it simply by applying the rules that the politicians expect the rest of us to abide by.

As we have seen, disclosure requirements are not sufficient to stop cronyism. What about trusts? Many members of Congress put their assets in so-called blind trusts, and thereby appear to be above suspicion. Yet such trusts don't work either. Despite the name, blind trusts are far too often not, well, blind. And they are not dumb either. Senator Robert Toracelli had a blind trust, and by picking a political acolyte and longtime friend as his trustee, Toracelli made a killing on illegally manipulated stocks.
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Senator Bill Frist had a blind trust where he held, among other things, shares of Hospital Corporation of America, a company started by his father. But that did not prevent the trust from making some well-timed stock sales, which set off an eighteen-month SEC investigation. Frist was cleared of all charges, but the episode highlighted the fact that a blind trust is not always blind. Politicians who have their assets in a blind trust whose trustees seem to show amazing deftness in predicting government actions need for serious scrutiny.

The rules of a blind trust are simple. You must select a trustee (it cannot be a family member) to direct the trust and deal with the investments. You cannot have a conversation with the trustee about the portfolio, and you cannot direct or suggest trades. Of course, what a politician can do is share nonpublic information, the kind that hedge funds pay a lot of money for, and then let the trustee make his own decision about how to react. As law professor Megan Ballard puts it, "The rules for these trusts do not include sufficient incentives to maintain blindness." Indeed, "blind trusts can mislead the public into believing that policymakers are avoiding conflicts, when they may not be doing so." As Ballard points out, the first elected U.S. official to use a blind trust was Lyndon Johnson, who was notorious for using his position to benefit his businesses. LBJ named two business associates and a family friend as his trustees. And he continued on as usual, with his trustees handling specific details.
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The simple fact is that politicians often select close colleagues, friends, and acolytes to run their blind trusts. Furthermore, once you establish a blind trust, according to the rules of the Senate, you are no longer required to disclose your assets annually, so it creates less transparency than before. Things that politicians are allowed to do in the dark are not always good.

Back in 1995, when legislators were arguing over the Congressional Accountability Act, which would subject Congress to federal antidiscrimination and other workforce protection laws, Senator Charles Grassley of Iowa said: "I hold the strong belief that we, in Congress, are merely representatives of the people. We are not better than the people we represent and we are not, by definition and determination, different from the people we represent. We are, as representative government intends, the people themselves."
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It's time for Grassley's argument to be applied to crony capitalism on both Capitol Hill and in the White House.

 

Henry Manne recognized in 1966 that "the federal government is the largest producer of information capable of having a substantial effect on stock-market prices."
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The author of the standard text on insider trading knew Congress was a rich source of privileged information. What do our laws say on the matter?

When it comes to current SEC insider trading laws, there is a spirited debate going on among legal scholars as to whether current laws actually apply to Congress. Many contend that they don't, because our legislators are not fiduciaries (that is, client representatives) and are therefore not obligated to keep secret information secret. Other scholars argue that SEC laws on insider trading do apply to members of Congress. They claim it is illegal under Rule 10b-5 of the Securities Exchange Act, which is a general antifraud provision that prohibits deceptive conduct "in connection with" the purchase or sale of securities.
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But even if current laws do apply, the political reality is that the SEC is not going to enforce them against Congress. Remember, the SEC is funded by Congress. And SEC commissioners require Senate confirmation. Congress has oversight over the whole operation. Remember what happened when the FBI raided Congressman Jefferson's office? His colleagues threatened to cut funding for the Justice Department. And recall from the introduction how everything from IRS enforcement rates to listings under the Endangered Species Act are directly influenced by congressional power.