Would you pay good money for accurate predictions about important events, such as election results or military campaigns? Not if the U.S. Commodity Futures Trading Commission (CFTC) has its way. It recently took enforcement action against overseas prediction markets run by InTrade and TEN. The alleged offense? Allowing Americans to trade on claims about future events.
The blunt version: If you want to put your money where your mouth is, the CFTC wants to shut you up.
A prediction market allows its participants to buy and sell claims payable upon the occurrence of some future event, such as an election or Supreme Court opinion. Because they align incentives with accuracy and tap the wisdom of crowds, prediction markets offer useful information about future events. InTrade, for instance, accurately called the recent U.S. presidential vote in all but one state.
As far as the CFTC is concerned, people buying and selling claims about political futures deserve the same treatment as people buying and selling claims about pork futures: Heavy regulations, enforcement actions, and bans. Co-authors Josh Blackman, Miriam A. Cherry, and I described in this recent op-ed why the CFTC’s animosity to prediction markets threatens the First Amendment.
The CFTC has already managed to scare would-be entrepreneurs away from trying to run real-money prediction markets in the U.S. Now it threatens overseas markets. With luck, the Internet will render the CFTC's censorship futile, saving the marketplace in ideas from the politics of ignorance.
Why take chances, though? I suggest two policies to protect prediction markets and the honest talk they host. First, the CFTC should implement the policies described in the jointly authored Comment on CFTC Concept Release on the Appropriate Regulatory Treatment of Event Contracts, July 6, 2008. (Aside to CFTC: Your web-based copy appears to have disappeared. Ask me for a copy.)
Second, real-money public prediction markets should make clear that they fall outside the CFTC's jurisdiction by deploying notices, setting up independent contractor relations with traders, and dealing in negotiable conditional notes. For details, see these papers starting with this one.
[Aside to Jerry and Adam: Per my promise.]
[Crossposted at Technology Liberation Front, and Agoraphilia.]
Wednesday, December 12, 2012
CFTC Targets Prediction Markets; Hits First Amendment
Monday, July 28, 2008
Nice to Be Wanted
Rather than blogging, I've been spending my summer attending conferences, hanging out with my family and friends, surfing, working on a paper about consent theory, and indulging in a new hobby: composing and performing songs at open mikes. I've set a goal of performing three new songs each time I play at my favorite local open mike, held the first Monday of every month. Much of what I've written doesn't concern legal or economics topics, though of course I invite interested readers to check out the songs I've written about romance, drinking, taoism, and so forth.
My most recent song, Nice to Be Wanted, offers a message that will surely resonate with friends of markets, however. Follow that link if you want the chords and other tips on how to play it. (Be forewarned: To nail the song's Country and Western style, you'll need to get your twang on.) Here are the lyrics:
Nice to Be Wanted
Verse 1:
You prob'ly think I live a boring life.
I pay my bills. I love my kids and wife.
But you can bet I've got an outlaw side.
Listen up! I'll tell ya' how I ride.
Verse 2:
For example, just the other day,
I turned right on a red—without stoppin' all the way!
Then I hit 38, drivin' back home,
Through a 35 miles-per-hour zone!
Refrain:
It's real nice to be wanted, by a purty little lady.
It's real nice to be wanted, by your lovin' ma and pa.
It's real nice to be wanted, by the folks who sign your paycheck.
But it's not nice to be wanted, when you're wanted by the law.
Verse 3:
But you know, I'm not the only one.
Some folks smoke and drink, before 21!
'N I heard tell, some guy in Oregon,
Pumped his own gas, at the fillin' station.
Verse 4:
A charmin' lady down New Orleans' way,
Dared to sell an unlicensed bouquet.
Her local florists don't like competi-shun.
They play monopoly—but not for fun!
Refrain
Verse 5:
We can't help it if we break some rules.
Politicians, and their fools,
Have rolled out red tape by the ton,
So they can keep us on the run!
Refrain
Coda:
The doggonned law.
The confounded law.
The nit-pickin', lousy, frickin, 'noveau-Prussian, freedom-crushin', law.
Fin.
As always, I've taken care to nail down the legal citations. The reference to Oregon concerns a statute (O.R.S. section 480.330) that forbids retail gasoline customers from pumping their own fuel. (New Jersey imposes a similar restriction, but does not admit the same easy rhyme.) The Louisiana florist's sad tale also proves all too true, as the Institute for Justice, champions for the would-be florist's rights, can tell you.
[Crossposted at Agoraphilia and Technology Liberation Front.]
Monday, July 07, 2008
Free Speech in Event Market Claims
In addition to a joint comment with a score of signers, I also responded to the Commodity Futures Trading Commission (CFTC)'s Concept Release on the Appropriate Regulatory Treatment of Event Contracts by firing off a solo comment. I there focused soley on question 14, in which the CFTC asked, "Should certain underlying events or measures--such as those based on assassinations or terrorist activities—be prohibited altogether due to the social perception and impact of such events? What statutory or other legal basis would support this treatment?"
Much of my comment tracked the answer I posted here earlier. Long story short: such claims would not materially promote wrongful acts, so the CFTC has no legal basis to ban them. To that argument, however, I added a First Amendment analysis; to wit:
Could you fault claims about assassinations or other terrorist events for giving incentives for wrongful acts? Not very plausibly; as I explain above, it is very unlikely that anyone would find it profitable or prudent to try to use an event market to cash in on wrongdoing. Furthermore, all sorts of investment instruments offer the same incentives. Thus, for instance, a would-be terrorist might go long on oil futures prior to pulling off an attack on a refinery. Indeed, that sort of scenario seems much, much more likely than one involving event markets.
At root, concern about unseemly event market claims boils down to concern about violating a taboo about what sorts of things people discuss openly in a polite society. Those norms merit our concern, granted. They do not, however, justify imposing a speech restriction on event markets. And make no mistake about it; to bar such claims would constitute a restriction on speech.
Specifically, if the CFTC banned certain sorts of event market claims relating to assassinations, terrorist activities, or criminal acts, it would thereby impose a content-based restriction on speech. That would, under present First Amendment jurisprudence, trigger the highest level of judicial review: strict scrutiny. The ban would almost certainly fail to survive that scrutiny, as it would be too broad (stopping not just the bad guys but also the good ones), too narrow (since it would fail to forbid the use of other financial instruments, such as generic futures, from like uses), and not narrowly tailored (since there are other, better ways to discourage bad acts). Those sorts of claims would, moreover, fall within the core of the sort of speech protected by the First Amendment, as they would concern political events.
Our freedoms of speech and expression include the right to ask troubling questions. The CFTC has no good reason to ban event market claims about assassinations or other illegal acts. Nor can it do so constitutionally.
Suppose that my argument leads the CFTC to doubt that it can ban event markets from hosting claims about assassinations or terrorist activities. Suppose further, as seems likely, that the CFTC has some discretion in deciding whether its jurisdiction encompasses event markets; suppose, that is, that extant law does not command one answer to that question. What result?
I predict that the CFTC would tend to deny that it has jurisdiction over event markets because it would not want to take the blame for encouraging distasteful claims. Indeed, I not only predict that result, I intend it. I don't trust the CFTC to do a very good job regulating event markets, so I want it to know why it does not even want to try.
[Crossposted at Agoraphilia and Midas Oracle.]
The CFTC Deadline . . . Wavers
The Commodity Futures Trading Commission (CFTC)'s Concept Release on the Appropriate Regulatory Treatment of Event Contracts says, "Comments must be received by July 7, 2008." What deadline does that impose? I played it safe, and assumed that I had to send mine in before midnight, this morning. Today, I learned from Bruce Fekrat, Special Counsel to the Office of the Director of the CFTC, that in fact I had up until this coming midnight to email my comments.
Any lawyer worth his or her salt knows better than to use the ambiguous "by" when specifying a deadline. The CFTC should have said, "Comments must be received before July 8, 2008." Thanks to its poor drafting, I rushed my comment out the door, missed the chance to get lots of new signatures, and wasted time swapping emails with various people equally confounded about what the CFTC meant.
Sigh. And to think that some people hope the CFTC will assert jurisdiction over prediction markets and clarify their legality under U.S. law! If the CFTC cannot get even something so routine as specifying a deadline right, I shudder to think what sort of confusion it might impose on prediction markets.
[Crossposted at Agoraphilia and Midas Oracle.]
Thursday, July 03, 2008
Let's Tell the CFTC Where to Go
Update: I've extended the deadline for signing up until 7 p.m. Pacific, Sunday, July 6. Also, I fixed a typo in paragraph 3, changing "denying" to "giving." (Thanks, Gil!)
The deadline looms for interested parties to respond to the Commodity Futures Trading Commission's request for comments about regulating prediction markets ("event markets" in the CFTC's usage). I may or may not get around to a detailed, point-by-point response to the CFTC's many questions. In the meantime, though, I've drafted a general statement that many of you might agree with. I invite you to sign it with me, so that together we might tell the CFTC where to go. Please see below for details on how to sign on. Here is the draft statement:
What regulatory treatment should the Commodities Futures Trading Commission ("CFTC") apply to event markets? We the undersigned, who represent a wide range of viewpoints, agree on three general observations. First and foremost, the CFTC should do no harm. Second, at a minimum, the CFTC should make more general the sort of "no action" status enjoyed by the Iowa Electronic Markets ("IEM"). Third, if the CFTC decides to regulate event markets more substantively, it should adopt clear and limited jurisdictional boundaries and allow affected parties to step outside of them.
First, do no harm: Many sorts of event markets—including public ones, private ones, ones that offer only play-money trading, and ones that offer real-money trading—already thrive in the U.S. They have provided a rich array of benefits without evidently harming anyone. The CFTC could help event markets achieve still greater success by clarifying their legality. Instituting the wrong sort of regulations could suffocate event markets in their cradle, however. The CFTC should exercise a light hand, taking care to do no more than offer qualifying event markets the shelter of federal preemption and freeing them to continue operating under the extant legal regime.
Second, open up the "no action" option: Thanks in part to the "no action" letters that the CFTC has issued to it, the IEM has for many years benefited the public by offering real-money event markets. No sound reason precludes the CFTC from giving similar treatment to other institutions that, like the IEM, offer event markets solely for academic and experimental purposes and without imposing trading commissions.
Although the CFTC's "no action" letters do not specify the exact criteria the IEM had to satisfy, they took favorable note of the IEM's account limits. Those account limits effectively prevent the IEM from supporting significant hedging functions. If the CFTC builds a similar requirement into any general "no action" guidelines, it should adopt limits considerably more generous than the meager $500/trader limit adopted decades ago by the IEM. Even a limit ten times that amount would still effectively preclude hedging.
The CFTC should not limit "no action" status to markets run by tax-exempt organizations. The no-action letters that the CFTC issued to the IEM emphasized not the nature of the hosting institution, the University of Iowa, but rather the business model adopted by the IEM itself. Profitability could not have mattered, as tax-exempt organizations can and do earn profits (indeed, as their burgeoning endowments demonstrate, many universities earn immense profits). The CFTC apparently cared only that the IEM did not plan to profit from charging traders commissions. A tax-paying organization could satisfy that condition just as easily as a tax-exempt organization could. In either event, price discovery would flourish and consumers would win a safeguard against getting fleeced.
Third, preserve regulatory exit options: If the CFTC decides to write substantive regulations for event markets, it should recognize and guard against the risk of overregulation. Even well-intentioned and well-informed regulators remain human and, thus, all too apt to make mistakes. They run an especially large risk of making mistakes when they first attempt to regulate new institutions, such as event markets. To make matters worse, regulators typically lack reliable signals to determine when they have gone too far. Industries wither away for many reasons, after all.
The CFTC's approach to regulating event markets should accommodate these policy considerations by establishing clear jurisdictional boundaries and preserving regulatory exit options. Thus, for instance, the CFTC might specify that it has no jurisdiction over event markets that offer trading only to members of a particular firm, over markets that offer only spot trading in negotiable conditional notes, or over markets that do not support significant hedging functions.
The CFTC's approach to regulating event markets should accommodate these policy considerations by establishing clear jurisdictional boundaries and opening exit options. Thus, for instance, the CFTC might specify that it has no jurisdiction over event markets that offer trading only to members of a particular firm, over markets that offer only spot trading in negotiable conditional notes, or over markets that do not support significant hedging functions. Then, if the CFTC enacts unduly burdensome regulations, an event market could opt out of them by changing its business model. So long as markets publicly announce that they operate outside the CFTC's purview, allowing them that freedom of exit would harm nobody. To the contrary, it would help the CFTC gauge the suitability of its regulations and serve the public by protecting the continued viability of event markets.
Interested in signing on? Please drop me a private email (tbell at chapman dot edu) with your name, institutional affiliation, and snailmail address. I welcome your comments—I'm sure a typo or two persists in my draft—but I of course cannot revamp the entire statement without mucking up the entire process. To leave me time to get everything together and out the door before the July 7 deadline, you'll have to contact me before noon Pacific time on Sunday, July 6.
[Crossposted at Agoraphilia and Midas Oracle.]
Monday, June 23, 2008
Let Prediction Markets Fight Terrorism
The Commodity Futures Trading Commission (CFTC)'s recent request for comments about the regulation of prediction markets includes a number of specific questions. I am not sure whether I will manage to write up answers to all of them before the July 7 deadline, but question in particular—question 14—has attracted my attention. The CFTC there asks, "Should certain underlying events or measures--such as those based on assassinations or terrorist activities—be prohibited altogether due to the social perception and impact of such events? What statutory or other legal basis would support this treatment?"
I answer the first part of question 14, "No," (and thus need not answer the second part). I doubt that the CFTC wants to hear that sort of reply, frankly; I instead suspect that it wants a legal excuse to avoid the sort of political firestorm that followed the Pentagon's proposal to create a Policy Analysis Market that included claims about assassinations and terrorist events. My draft answer to question 14 explains why I'm willing to risk disappointing the CFTC:
The CFTC should not forbid trading in claims based on assassinations, terrorist activities, or other criminal acts. Because event markets would offer only relatively thin and traceable trading, they would not offer an attractive investment option to anybody planning to profit from wrongdoing. A would-be terrorist would risk revealing both his plans and his identity if, for instance, he invested in a contract predicting another 9/11. He would instead find it more safe and profitable to simply short certain publicly traded stocks.
Furthermore, event markets in terrorist or criminal acts might benefit the public by revealing life-saving information. Suppose, for instance, that an anthropologist's study of corrido culture convinced her that narcoterrorists had begun planning military raids on border checkpoints in Arizona and California. If she had the opportunity to buy terrorist event claims, she might both profit from her research and tip us all off about looming trouble. Sound public policy suggests that we should encourage that sort of trading—not forbid it.
To judge from their reactions to the Policy Analysis Market proposed by the Pentagon in 2003, politicians might need to learn more about the benefits of using trading to help predict assassinations or other terrorist events. That poses a public relations problem, however—not a legal one. The CFTC thus has no sound reason to presumptively forbid trading in contracts related to such events.
Notably, my answer to question 14 differs sharply from the answer offered by Jed Christiansen. He said, "There should never be any incentive to break a law, so there should never be any contracts that would pay someone if a law was broken." I disagree, of course, but I thank him for stimulating me to offer an alternative take.
[Crossposted at Agoraphilia and Midas Oracle.]
Monday, June 16, 2008
Krugman on Food Safety
Paul Krugman kvetches, “Without question, America’s food safety system has degenerated over the past six years.” Alex Tabarrok smacks him down with actual data, showing the trend in food-borne disease outbreaks is clearly downward.
But what struck me about Krugman’s column was the following, offered as evidence that the FDA is falling down on the job: “What we do know is that since 2001 the F.D.A. has introduced no significant new food safety regulations except those mandated by Congress.”
What wacky theory of regulation says we must have new food safety regulations every year? It’s not as though the old ones expire. Even if you believe that government regulation of food safety is justified and important, that doesn’t mean the total regulatory burden has to increase every year.
I suppose that changing times might require changing regulations. Maybe. But unless there are substantial changes in our eating habits or food production techniques, we should then expect modest and incremental regulatory changes over time. Yet Krugman says there have been no significant new food safety regs – thereby indicating that the FDA has, in fact, created new safety regulations in the last seven years, but that’s not good enough for him. Krugman also indicates that Congress has approved significant new food safety regulations.
So to summarize: (1) it’s not enough for the FDA to maintain existing food safety regs; (2) it’s not enough for the FDA to create modest additional regs on top of existing legislation; and (3) it’s not enough for the FDA to create modest additional regs on top of significant new legislation. Nope – for the FDA to meet Krugman’s exacting standards, it must always be creating new and significant food safety regulations every year, on top of both existing regulations and new mandates passed by Congress. And that is Krugman’s beef with the FDA.