Government is a trust, and the officers of the government are trustees, and the both, the trust and the trustees, are created for the benefit of the people.
—HENRY CLAY
THERE'S A STORY about a politician who returns from Washington to his home district to run for reelection. When his constituents learn that he is not yet a millionaire, they promptly vote him out of office. He must be stupid.
There seems to be only one sure-fire way to prevent the Permanent Political Class from getting drummed out of power: maintain extremely low standards. We have come to accept minor indiscretions, financial malfeasance, and profiteering on the taxpayer dime as regular occurrences. And as those indiscretions and crimes (for the rest of us) mount up and become more common, we become even more tolerant of them. The standards become lower still. To steal a phrase from the late Senator Daniel Patrick Moynihan (on a different subject), we have defined deviancy down in Washington. The quality of our leadership is so low because we expect so little.
The political class is able to exploit honest graft because they have been given a position of privilege and power, and they work very hard to persuade us that their well-being is necessary for our well-being. They work very hard to persuade us that they, and only they, are capable of "running" the country, or "managing" the economy. This, of course, is the classic appeal of the con: I may be a rogue, but I'm indispensable. George Washington Plunkitt made a similar appeal for Tammany Hall. Without the political machine in place, he warned, "it would mean chaos. It would be just like takin' a lot of dry-goods clerks and settin' them to run express trains."1
At the root of the Permanent Political Class is a profound sense of arrogance. A good military commander should never consider himself to be irreplaceable, but many politicians in Washington believe precisely that of themselves. It is an ugly form of elitism, less overt than what we would see from the royalty of Europe in the seventeenth and eighteenth centuries, when the Sun King could proclaim, "I am the state." The modern, subtler version of this arrogance is the politician's belief that if we restrict his ability to engage in legal graft, the nation will suffer, because we won't be able to attract bright people (like them!) to run the country.
Over the past forty years we have been governed by the best-educated political class in our history. Today, debts mount, the financial markets are in turmoil, the economy is in terrible shape—and the Washington games continue. The problem is not a lack of smart people in Washington. There is no "smart gap." There is, however, a "character gap." Like the financial crisis on Wall Street, the root of the problem is not ignorance but arrogance.
The Permanent Political Class tells us: We need them. Only they can dissect the entrails of the latest bill or understand the complexities of financial reform. They are making so many sacrifices on our behalf, they say. They are smart and well educated and could be making a lot more money somewhere else, they claim. We should tolerate a little honest graft on the side, or the occasional financial indiscretion, like failing to report income on their tax returns.
Yet, of course, the political class is hardly the only group of people in the country making a sacrifice for public service. Our soldiers are underpaid. Those who enter West Point, the Air Force Academy, or Annapolis, or those who go through ROTC at a rigorous school, are just as smart. They certainly could be doing something else with their time. They choose the armed forces as an act of service; they are not looking to get rich as officers. Enlisted soldiers are not looking to cash in by joining the infantry. In the military they will never earn anything close to what they might earn in the private sector. And many of our best leaders over the last century or more have come out of our armed services. These are individuals who could have been running large corporations or institutions for far more money. Two-, three-, and four-star generals make less than a freshman member of Congress, even though they may be responsible for the safety and operation of more than 100,000 troops. If today we had a five-star general like Dwight Eisenhower—and we don't—he would still be paid less than a freshman congressman.2 And yet it is impossible to imagine that the military brass would ever argue that they deserve to make a little "on the side" as indirect compensation for their service.
Indeed, in the early 1980s, when the United States was in the midst of another (smaller) budgetary crisis, President Ronald Reagan released to the public letters he had received from American soldiers serving in Europe. They weren't griping about possible cuts. Just the opposite: they offered to take a pay cut if it would help the country. When was the last time you heard a member of the Permanent Political Class offer to do that?
When Gordon England was appointed to become deputy secretary of defense in 2006, members of the Senate committee that would hold hearings and vote on his confirmation had a simple and blunt request: You must give up the lucrative stocks and options you have in companies that do business with the Pentagon. Such divestment had been a requirement of the Senate Armed Services Committee of senior Pentagon appointees for decades, designed to eliminate any "military-industrial complex" conflict-of-interest concerns that might arise. The restriction was not limited to just missile manufacturers or companies that made bullets. "We're not allowed to buy Coca-Cola stock because military guys drink Coke," said England, "and we couldn't have stock in cereal companies because military guys eat cereal."3
And who were the senators sitting across from England at those hearings? The same senators who wrote the defense bills, added earmarks, determined which military systems were bought or rejected. The same senators who were privy to private conversations with contractors and Pentagon officials, and received classified briefings on defense contracts, military systems, and Pentagon strategy. In other words, the very people who controlled the federal budget. They were free to buy and sell as many shares of defense stocks as they wanted to. Indeed, 19 of the 28 senators on that committee at the time held stock in companies that do business with the Pentagon.
The Permanent Political Class tells us they are concerned about financial corruption and financial crimes. They applaud legal crackdowns on corporate criminals and berate corporate executives for their huge salaries and tax shelters. The Permanent Political Class believes that everyone needs to be policed on this front. Everyone, that is, except for themselves. Why did the Tammany Hall political machine gain so much power in New York City? Why was it a dominant force for more than a century? You could point to the patronage system, or the payoffs. But in the end the machine survived because the public came to accept it. New Yorkers came to tolerate the idea that you could use "legal graft" to get rich from "public service" because that was just the way things were done. Sadly, the same attitude holds true today when it comes to crony capitalism. We get outraged when members of Congress or the President breaks the law, but we ignore the legal graft that is far more prevalent.
As long as the Permanent Political Class gives us what we want, we are happy. This was precisely the goal of Tammany Hall: make people dependent on us. Plunkitt explained that the fondest dream of bosses like himself was a situation where "the people wouldn't have to bother about nothin'. Tammany would take care of everything for them in its nice quiet way."4
America is supposed to be a nation ruled by laws, not by men. Central to that idea of America is the notion that we are equal before the law. That means that the laws should apply equally to everyone.
For one of the chief architects of the Constitution, this notion of equality before the law was the "genius of the whole system." As James Madison wrote in Federalist No. 57: "I will add, as a fifth circumstance in the situation of the House of Representatives, restraining them from oppressive measures, that they can make no law which will not have its full operation on themselves and their friends, as well as on the great mass of society. This has always been deemed one of the strongest bonds by which human policy can connect the rulers and the people together. It creates between them that communion of interests and sympathy of sentiments, of which few governments have furnished examples; but without which every government degenerates into tyranny."
Why do the American people feel detached from Washington? Why are they fed up? Why do they feel little connection to their elected leaders? Why do our lawmakers in Washington seem to show so little urgency? Part of the answer lies in the fact that politicians are allowed to operate by a different set of rules. And that is a dangerous place for a representative government to find itself.
The Permanent Political Class is unresponsive to our concerns and needs because it is partly immune to the economic realities the rest of us face. Its business has, in a phrase popular with money managers, downside protection and guaranteed upside potential. For crony capitalists, there is a business cycle, but they control it and can make money no matter how and when it turns. This means socialism for the Permanent Political Class and its friends—and capitalism for the rest of us.
The Permanent Political Class offers all sorts of arguments to justify its special status and its exemption from conflict-of-interest and insider trading laws. Members of Congress will argue, for example, that they are required to disclose their financial transactions and assets, and voters can boot them out at the ballot box. Never mind that those financial disclosure forms are often filled out incompletely or incorrectly. According to the congressional newspaper Roll Call, 25% of them contain significant errors.5 The point is, many lawmakers believe they must be kept above the fray, beyond the reach of the executive branch. They regularly exempt themselves from the level of scrutiny placed on other national leaders. They have even exempted themselves from Freedom of Information Act (FOIA) laws and open-document requirements. Their documents are as legally inaccessible as secret documents of the CIA—in fact, they are more difficult to obtain. At least some CIA documents become declassified and see the light of day. Congressional records never do. Congress passed the FOIA in 1966 because it believed that informed citizens would be better watchdogs. But Congress didn't want them looking into its own backyard.
Financial disclosure forms are required for elected state legislators, state judges, and county or city commissions around the country. But public officials are also required to abide by conflict-of-interest and insider trading laws and restrictions. If elected state judges, for example, were held only to the standards of federal lawmakers, they would be free to rule on cases in which they had a financial stake, as long as they faced reelection and filed financial statements. Would anyone like that idea?
In forty-five states, one or both state legislative bodies have a requirement that if a financial conflict of interest exists, a member legislator "shall not vote on the matter."6
American city councilors and county commissioners often have stricter rules than members of Congress, even though they have far less power and influence. In California, for instance, if you serve on a city council or county commission, you are subject to conflict-of-interest laws. As the state defines it, "You have a conflict of interest with regard to a particular government decision if it is sufficiently likely that the outcome of a decision will have an important impact on your economic interests." California has an oversight body, the Fair Political Practices Commission. One of the standards it uses is the "personal financial effect." If voting on a bill will cause you to gain or lose $250 or more in a twelve-month period, you should abstain.
The commission offers this hypothetical example: "The Arroyo City Council is considering widening the street in front of council member Smith's personal residence, which he solely owns. Council member Smith must disclose on the record that his home creates a conflict of interest preventing him from participating in the vote. He must leave the dais but can sit in the public area, speak on the matter as it applies to him and listen to the public discussion."7 In other words, he can voice his opinion like any other citizen, but he cannot help make a ruling on the matter.
For members of Congress, not only are they allowed to vote in similar circumstances, they can also quietly insert an earmark into any big bill in order to widen the road in front of their house. As long as one other person lives on that road, the ethics committee will sign off on it.
Some people argue that members of Congress shouldn't be forced to comply with the same laws as the rest of us, because if they were, good candidates wouldn't run for office. Or that if they were required to recuse themselves, voters back in their districts would be disenfranchised. This is true, in the narrow sense that each recusal means certain voters' interests are not spoken for. But the grand claim of disenfranchisement should not be overused. Does anyone complain about disenfranchisement when a legislator skips a vote?
Members of Congress love to raise the banner of "separation of powers." When the FBI obtained a warrant to search Congressman William Jefferson's office in 2006, both Speaker of the House Dennis Hastert and Majority Leader Nancy Pelosi denounced the move as dangerous and unconstitutional. Jefferson was at the center of a fourteen-month investigation into charges that he accepted bribes. The FBI already had video evidence of Jefferson taking $100,000 in bribe money, and the Bureau found $90,000 in cash in his apartment freezer. But on Capitol Hill, the Permanent Political Class saw the raid as an outrage. Congressmen complained that FBI agents showed up at the Rayburn Office Building unannounced (imagine that!) and demanded that the Capitol Police let them into Jefferson's office immediately or they would "pick the office door lock." Some in Congress even threatened to retaliate by cutting the budget of the FBI and the Justice Department.8 A federal judge dismissed these criticisms, arguing that Jefferson had turned his office into "a taxpayer-subsidized sanctuary for crime."9 Of course, the judge was correct. It is understandable that members of the legislative branch would bristle at the use of coercive force by the executive branch against them, but not every example denotes a return to the civil wars of the British monarchy against Parliament.
Our legislators cling to the Speech or Debate Clause of the Constitution. Article 1, section 6 states that members of Congress "shall in all Cases, except Treason, Felony and Breach of the Peace, be privileged from Arrest during their Attendance at the Session of the respective Houses, and in going to and returning from the same; and for any Speech or Debate in either House, they shall not be questioned in any other Place."
That clause is not a get-out-of-jail-free pass for wrongdoers. It was designed as a safeguard against politically motivated legal action by the executive branch. British monarchs had used civil and criminal laws to block legislators who opposed the king. Who knew that over two hundred years later the legislative branch would use this as a shield against searches for criminal evidence?
If our elected representatives in Washington really want to cite the Constitution, they might begin with the Preamble: "We the People ... ordain and establish this Constitution." We, the people of the United States, contractually grant Congress its rights. The Constitution is a contract between the people and the elected. When members of the Permanent Political Class use their public office for personal interest, they have breached that contract.
It was in the 1940s when the word "crony" was first applied to modern American politics. Arthur Krock, the famed New York Times reporter nicknamed "the dean of the Washington newsmen," used it to criticize the political machine—like methods of the Truman administration, and later applied it to others. Alluding to President Truman's former connections to the Kansas City political machine of Tom Pendergast, Krock wrote in 1946 that "the Missouri flavor is strong around the White House itself ... and this has led to talk of government by crony." Harold Ickes, Truman's secretary of the interior, resigned from the administration in February of that year, saying, "I am against government by crony." Renowned journalist Walter Lippmann also used the term to criticize the Truman administration in a 1952 New York Times article, making reference to "the amount of politically entrenched bureaucracy that has earned for Mr. Truman's regime its sorry reputation for corruption, cronyism, extravagance, waste and confusion." After Truman retired from Washington, the word "cronyism" came up frequently in American politics—the Eisenhower, Kennedy, and Johnson administrations were all subject to charges of "influence peddling, conflict of interest, gift giving, and the like."10
We have seen waves of hearings, from Truman to Johnson to Nixon and so on, over scandals now mostly forgotten. Does anyone other than political junkies remember Abscam or the Keating Five? There have also been waves of reform efforts and rules changes, including the Ethics in Government Act (provoked by Watergate). Yet politicians continue to enrich themselves, their families, their friends, and their supporters through the practice of cronyism.
Montesquieu wrote in The Spirit of the Laws, "Commerce is the profession of equals." But not in an era of crony capitalism, where politicians increasingly call the shots and where better access is often more important than a better idea or better business plan. Business has often resembled a meritocracy: the entrepreneur with the best idea, the best product, the best business strategy, wins. People vote with their purchases to select winners and losers. And investors looking to help a budding company will make their evaluation on the merits. Cronyism is the antithesis of a meritocracy.
Andrew Redleaf is the CEO of Whitebox Advisors, a highly regarded investment advisory service. Redleaf has had a long career running investment funds. He argues that crony capitalism isn't just unfair, it is a serious threat to our economic system, because "crony capitalists do not depend upon the general success of the economy to achieve their larger goals ... The crony capitalist is instinctively satisfied with the notion of a zero-sum game, which, for his purposes, is better than a rising tide that lifts all boats. What good is it to the crony capitalist to see all boats lifted?"11
The crony-capitalist system is self-perpetuating. When they leave office, politicians become cronies of their former colleagues. Consider this simple statistic concerning the number of government bureaucrats and ex-politicians serving on corporate boards. In 1973, only 14% of Fortune 1000 companies had people with "government service experience" on their boards. By 1992, it had jumped to 39%. Since 2002, it has been over 50%. These numbers are even more stunning when you discover that during the same period the average number of outside directors on corporate boards has shrunk from 16 to 9.12
As one unnamed corporate executive put it, "We need someone on the board who is a veteran of the Washington scene, who knows and understands the people involved in the executive and legislative branches of the government, and who keeps an eye on what is going on in Washington. Somebody who has had Washington experience does make a great contribution to our board."13 More and more, corporate leaders are coming to agree.
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.14 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.15
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.16
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%.17
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.18That'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."19 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.20
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.