Somewhere in lower Manhattan, Preet Bharara oughta be licking his chops.
We now have the clearest evidence yet that bank executives traded on insider information during the financial crisis. A study released this week shows that financial insiders with connections to government regulators traded in anticipation of bailout announcements, giving them a distinct edge at the expense of all other shareholders.
In the words of the study’s abstract: “Politically connected insiders had an information advantage during the crisis and traded to exploit this advantage.” Sounds bad, right?
Though it adds to ampleexistingliterature around bank trading around the time of the financial crisis, the paper that hasn’t gotten nearly as much public attention as one would expect from a topic that brings together so many issues that reliably stir up political bile: bad bankers, revolving-door politicians, insider trading, bailouts.
Presumably, there’s someone on this at the U.S. Attorney’s office in Manhattan. But maybe we should just wait and see.
The paper originated when researchers at four universities linked up to see whether insider trades at financial institutions anticipated the crisis. Insider trading in this usage doesn’t necessarily mean anything nefarious or illegal -- i.e., executives trading on material, nonpublic information in order to make a buck. Rather, this is the industry-jargon definition of insider trading, meaning any stock transaction carried out by a corporate executive or board director.
These latter kinds of trades have to be promptly disclosed every time they occur, providing a rich fabric of data for enterprising researchers (or anyone else on the internet).
Using insider data from some 7,300 officers at nearly 500 companies, the researchers tested whether corporate insiders anticipated the crash through their trades. The evidence came up short. Yet the researchers noticed what one author called a “blip” in profitable insider trading, which lasted from late 2008 to early 2009.
That happened to be precisely the time when the U.S. government was doling out some $700 billion in bailout funds through the Troubled Asset Relief Program, or TARP. Drilling deeper, the researchers saw that the profitable trades were clustered in those banks that got TARP money. In the weeks before a TARP disbursement was announced, insiders at the beneficiary banks tended to trade in just the right way to make a profit or avoid a loss.
But the pattern goes even deeper. Insider trades were the most informative -- i.e., the stock went up after insider stock purchases or fell after sales -- for executives with close connections to government. The paper calls them “politically connected insiders,” meaning any officer or director at a bank where a board member or members previously worked for the Federal Reserve or another government regulator.
For these lucky individuals, insider trades before bailout announcements turned into quick profits. Politically connected insiders who bought shares in the thirty days before their firm received a TARP goodie-bag saw returns of 4.4 percent, on average, in the three days after the announcement. Not bad! If on net they sold stock, shares fell 5.1 percent after the news hit.
Intriguingly, for banks lacking in political connections, insiders did about average in their trades. It was only those who had friends in high places who made extra-profitable mid-crisis portfolio decisions.
What’s more, the well-connected insiders traded much more than their peers, moving an aggregate $105 million in the month before TARP announcements, compared to around $30 million a month during other periods.
Striking as the results are, they weren’t what the researchers set out to find. “Frankly we’re still kind of stunned at the results,” said Daniel Taylor, co-author and professor of accounting at the University of Pennsylvania’s Wharton School, in an interview with the school’s online business journal.
Still, it may be a bit too early to break out the tar and feathers. “It would be wrong to suggest that this paper has sort of a smoking gun,” Taylor said. “Insider trading is a dark room, and we’re shining a light.”
Yet the broader political implications are evident. One one hand, there’s the revolving-door problem, a favorite hobbyhorse of Warrenites. “If the bailout is being decided in private and in consultation with bankers or treasury officials or government officials,” Taylor said, “how does that information leak out?” Quite predictably, his research would suggest.
Then there are the shareholder concerns. When insiders trade on nonpublic information -- such as a historically unprecedented government intervention in financial markets -- they extract rents from existing shareholders. Said Taylor: “If the executives traded with private information, it’s other shareholders who potentially are on the other side of that trade, and they lose out.”
It’s easy to take these results and hypothesize about rent extraction and a further fraying to the already-tattered fabric of public trust in government regulators. But it’s a whole lot harder to pin an case on one of the scores of politically connected insiders implicated in the study.
In part, that’s because insider trading has never been clear-cut, with definitions of “non-public” and “material” subject to endless Kabbalistic wrangling and dispute. And in recent years these cases have grown even harder, following a court decision in December 2014 that raised the hurdle for proving a violation. More than a dozen decisions against hedge funds have since been overturned; the Supreme Court is now set to deliver the final word on insider trading.
Still, as the FBI recently revealed, there are dozens of insider trading cases waiting patiently to be disclosed, among some fifty ongoing investigations. Despite setbacks, it appears the Feds are itching to keep the gods of insider trading satisfied with fresh sacrifices.
Then again, if political connections can help insider trading decisions, they can also help shield executives from prosecution. A friend in D.C. is a friend indeed.