Throw Them All Out (6 page)

Ironically, on July 24, Bachus wrote to the Securities and Exchange Commission requesting that it extend an emergency order intended to curb naked short selling. Some analysts were blaming the high volatility of the crisis on speculators who made short-term bets on stock prices by shorting them. A "naked short" refers to short-selling a stock without first borrowing it, or ensuring the ability to borrow it. This is highly risky for the seller, and it greatly increases the potential amount of short selling, since anyone can do it, whether or not he can afford it, and whether or not the stock being shorted is even available. Bachus himself was not guilty of naked short selling; he was always careful to put in play small amounts of money that he could afford to lose. But naked short sellers are really just an extreme version of all short sellers, and he was actively engaged in betting on the markets to fall.

 

Bachus was neck-deep in crucial financial decision-making at the highest levels. A few weeks later, he sent a letter to the Financial Accounting Standards Board, an independent private-sector organization, expressing concerns that proposed accounting changes might put at risk $10.5 trillion worth of securitized assets. Bachus wanted to see an end to mark-to-market accounting, in which an asset or liability is priced based on the current market value, and instead allow financial institutions and others to price liabilities based on the value when they are acquired.
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His position was certainly defensible, and it shows he was properly active and concerned with the state of financial markets. But he was not exactly disinterested in those markets.

Bachus kept trading. On August 15 and August 22, he bought more than $11,000 worth of SPDR sector option contracts. A few days later, he pocketed more than $5,000 in capital gains because he "guessed" right.

On the evening of September 18, at 7
P.M.
, Bachus received another private briefing for congressional leaders by Hank Paulson and Federal Reserve Bank Chairman Ben Bernanke about the current state of the economy. They sat around a long table in the office of Nancy Pelosi, then the Speaker of the House. These briefings were secretive. Often, cell phones and Blackberrys had to be surrendered outside the room to avoid leaks.
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What Bachus and his colleagues heard behind closed doors was stunning. As Paulson recounts, "Ben [Bernanke] emphasized how the financial crisis could spill into the real economy. As stocks dropped perhaps a further 20 percent, General Motors would go bankrupt, and unemployment would rise ... if we did nothing." The members of Congress around the table were, in Paulson's words, "ashen-faced."

Bernanke continued, "It is a matter of days before there is a meltdown in the global financial system." Bachus was among those who spoke. According to Paulson, he suggested recapitalizing the banks by buying shares.
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The meeting broke up.
The next day,
September 19, Congressman Bachus bought contract options on Proshares Ultra-Short QQQ, an index fund that seeks results that are 200% of the inverse of the Nasdaq 100 index. In other words, he was shorting the market. It was an inexpensive way to bet that the market would fall. He bought options for $7,846 on a day when the Dow Jones Industrial Average opened at 8,604. A few days later, on September 23, after the market had indeed fallen, he sold the options for over $13,000 and nearly doubled his money.

He continued in this vein, making short-term bets lasting between a day and a week, benefiting on 100-point swings. Meanwhile, the Treasury Department had worked with congressional leaders (including Bachus) to cobble together the $700 billion
TARP
rescue plan. The plan was publicly announced on September 22. Bachus made another options buy on Proshares Ultra on the day of the announcement. The congressman nearly doubled his money again, bringing in an additional $2,081 in capital gains.

On September 23, the House voted against the bailout as proposed by the Treasury Department. Amendments and revisions were offered. Bachus would later be criticized by his Republican colleagues for waffling on the bill: at first he was for it, then against it, then for it again. As the bill was recast and modified, Bachus's Financial Services Committee continued with private consultations. It was not until October 3 that the revised $700 billion bailout plan passed in the House and was signed into law by President Bush. At the signing ceremony in the Rose Garden of the White House, President Bush praised Bachus's work.

The bill gave the Treasury Department the power to purchase the toxic debt on banks' balance sheets. Paulson and others remained extremely concerned about the financial situation. Bachus was well aware of where things stood, but was apparently confident that the federal bailout would do the trick. He continued trading options, this time buying shares in an index fund known as Powershares QQQ, which tracks one hundred of the largest nonfinancial companies on the Nasdaq exchange. He bought into the fund on more than ten occasions in October, and he purchased options on the S&P 500 index six times. These were "calls"—that is, bets that the market would rise. Not all of Bachus's trades made money. These were still bets, and sometimes he bet wrong.

On October 14, the federal government tapped into the $700 billion provided by the Emergency Economic Stabilization Act. The government took equity positions in banks that chose to participate.
The next day,
Bachus bought more SPDR option contracts and netted a quick $3,400. On October 21, the Federal Reserve announced it would spend $540 billion to purchase short-term debt from money market mutual funds.
The next day,
Bachus bought more than $5,000 worth of options in Market Vectors TRN. Thanks to his purchase of this call, he more than doubled his money.

Bachus was not just buying options based on broad market funds or a sector of the economy. He also bought options on specific companies. On September 8, Hank Paulson received a disturbing private phone call from General Electric CEO Jeffrey Immelt. GE was having trouble selling its bonds, Immelt quietly told him.
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Just two days later, Bachus bought General Electric call options. He did so four times in a single day, according to his financial statements from Fidelity, and more than doubled his money.
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Indeed, between September 10 and 15, Bachus traded GE a total of twelve times. Nine of those trades were profitable—a huge batting average for such a risky game. Is there absolute proof that Paulson told Bachus about Immelt's phone call? No. Are Bachus's trades suspicious? You bet. Why did he bet so heavily on a company whose business is heavily in financial services?

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.
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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."
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The next day, Congressman Jim Moran, Democrat of Virginia, a member of the Appropriations Committee, dumped his shares in
ninety
different companies.
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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.
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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.
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By 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.