Why does the CFTC allow the Cantor Exchange and not InTrade?

Joe Weisenthal has a small opinion piece on why the CFTC allows real-money prediction markets on movie business, and bans those on politics or sports. The problem in the piece is that Joe is 100% wrong.

  1. Joe says that there can&#8217-t be hedging in politics. Wrong. You can hedge your political ads on InTrade.
  2. Joe says that there can&#8217-t be hedging in sports. Wrong. Businesses that operate inside a stadium could hedge the risk of the home team losing (which means less business for them).

So. why does the CFTC shy away from hedging on sports and politics? &#8211-&gt- Politics. The CFTC is afraid of the US Congress, who would object to politics and sports &#8220-gambling&#8221-.

The CFTC is a weak institution, in the DC sphere of power. In the recent past, the CFTC lost one important battle against other parts of the US government &#8212-even though it was the CFTC that was on the right side of the issue at the time. With politics and sports betting, the CFTC does not want to lose another battle. It is a question of survival.

Ayn Rands influence on Alan Greenspan is responsible for the 2008 financial crisis.

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Or so is PBS&#8217-s thesis in &#8220-The Warming&#8221-.

Pretty convincing.



Brooksley E. Born is an American attorney and former public official who, from August 26, 1996 to June 1, 1999, was chairperson of the Commodity Futures Trading Commission (CFTC), the federal agency which oversees the futures and commodity options markets. During her tenure on the CFTC, Brooksley Born warned Congress and the President of the need to regulate financial instruments known as over the counter (OTC) derivatives, but her warnings were disregarded. Lack of regulation ultimately led to the crash of the derivatives market, and helped trigger the economic and financial crisis in the fall of 2008.

The Commodity Futures Trading Commission and Securities and Exchange Commission will have authority to decide what derivatives must be centrally cleared rather than letting private parties make the call.

&#8220-Central clearing interposes a regulated clearinghouse between the original counterparties in a derivatives transaction and so creates an opportunity to make dealing more transparent.&#8221-

CNBC video

American Civics Exchange = CFTC-regulated Exempt Board of Trade

American Civics Exchange is enabling what InTrade (circa 2006, when they applied for the eBOT status) couldn&#8217-t&#8230- &#8212-getting the CFTC stamp of approval, and running a real-money prediction exchange from within the US territory (as opposed to offshore). The ACE does not have any direct domestic competitor, right now, but HedgeStreet could enter the political turf, later on.


American Civics Exchange is a play-money and real-money prediction exchange focused on politics. Its contracts pay out depending on whether given political outcomes (e.g. enactment of legislation, regulatory decisions, etc.) take place. The contracts are based on the idea of &#8220-event derivatives&#8221- &#8212-pretty much like the weather derivatives that enable companies that are financially exposed to deviations in temperature (utilities, farms, etc.) to hedge that exposure. The ACE political contracts enable any commercial companies to hedge their financial exposure to things like increased tax rates, enactment of harmful legislation, and adverse regulatory decisions. Speculators are also welcome, of course.

The seven initial contracts are:

  1. Increase capital gains/dividend income tax rates-
  2. Elimination of the manufacturers&#8217- tax deduction for oil companies-
  3. Enactment of &#8220-card check&#8221–
  4. Enactment of &#8220-cap and trade&#8221–
  5. The EPA granting California&#8217-s Clean Air Act waiver-
  6. Increase in the minimum wage-
  7. Taxation of carried interest as regular income.

The future prediction markets might feature these topics:

  1. Various new financial services regulations-
  2. Additional industry bailouts-
  3. Major healthcare reform-
  4. FDA drug approvals-
  5. Windfall profits tax on oil companies-
  6. Renegotiation/dissolution of existing trade agreements-
  7. Resolution of major class action lawsuits.

The Delaware-incorporated American Civics Exchange will be operating as an &#8220-exempt board of trade&#8221- pursuant to CFTC regulations, the Commodity Exchange Act, and the Commodity Futures Modernization Act. Last week&#8217-s launch consists solely of the play-money prediction exchange, with free accounts available to the general public. In the coming weeks, the real-money prediction exchange will open shop. Eligible contract participants [see 1(a)12] will then fund their accounts and begin live trading.

UPDATE: On February 10, 2009, the American Civics Exchange received an official acknowledgment from David Stawick, Secretary of the CFTC. The CFTC website, however, does not yet list ACE in their directory of eBOTs. It will, ultimately.

What ACE says (in their media kit) about hedging:

To offset a hypothetical $100,000 negative exposure to a proposed increase in the capital gains tax rate, a market participant would place a bid on 1,000 contracts. If that order were filled at $30, the position would cost $30,000 (excluding transaction costs). Matching such a bid does not require a coincident order to sell 10,000 contracts. As with established exchanges, the liquidity of a robust marketplace of buyers and sellers will enable even large orders to be automatically matched to batched bids submitted by an unlimited number of participants, including both speculators and natural hedgers.

If the tax increase is enacted before 12/31/10, the contract holder would receive $100,000, offsetting the impact of the tax increase. The contract holder can also sell the contract back into the marketplace at the prevailing price at any time before the expiration date, provided another party is willing to purchase the contracts at that price.

Press release:

Online Futures Market Enables Participants To Hedge Exposure To Political Events

NEW YORK, March 20 /PRNewswire-USNewswire/ &#8212- American Civics Exchangecorp, Inc. announced today that it has launched The American Civics Exchange, the first US-based commercial market for political futures. The Exchange enables traders to hedge and speculate on political risk through derivative contracts based on the outcomes of underlying events, including increases in tax rates, enactment of &#8220-card check&#8221- legislation, increases in minimum wage rates, enactment of &#8220-cap and trade&#8221- legislation, and other legislative, regulatory, and legal outcomes.

The ability to offset exposure to such events using contracts traded on the Exchange will enable risk managers and investors to reduce unwanted risk and protect themselves from adverse political outcomes. All contracts that trade on the Exchange are binary in nature, meaning they settle at $0 or $100, and are fully cash-collateralized, eliminating any counterparty, credit, or clearing risk.

The Exchange&#8217-s initial launch consists of a &#8220-play money&#8221- market for prospective participants and interested members of the general public. This launch will be followed by the roll-out of the &#8220-real money&#8221- market, which will be open only to eligible contract participants (as defined in the Commodity Exchange Act). The play money market will continue to operate parallel to the real money market and will remain available to individuals not eligible to trade in the live market, members of the press, academic and policy researchers, and other interested parties. In coming weeks, the Exchange will phase in additional collaborative and community-based tools for trading and research.

Philip &#8220-Flip&#8221- Pidot, one of the founders and the CEO of the Exchange, said, &#8220-The inauguration of a new Presidential administration and the unprecedented legislative and regulatory changes being considered in response to the financial crisis have only magnified the bottom-line impact of public policy decisions. For the first time, businesses and individuals have a market-based solution to hedge against these uncertain political risks.&#8221-

The American Civics Exchange operates as an Exempt Board of Trade pursuant to federal law and CFTC regulations. Users can register accounts and trade through the secure online trading platform located at http://amciv.com.

Requests for additional information can be directed to info@amciv.com or (646) 257-2426.

For media inquiries, please contact Audrey Mullen at audrey@advocacyink.com or (703) 548-1160.

American Civics Exchange

UPDATE: The Hill on ACE&#8230-

Gary Gensler will head the Commodity Futures Trading Commission in 2009.

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Barack Obama has named Gary Gensler, a former Treasury official under President Bill Clinton, to take over the Commodity Futures Trading Commission (CFTC).

New York Times:

Mr. Obama has vowed to reverse the deregulatory stance of the Bush administration and overhaul the entire system of financial supervision. Though Mr. Obama’s team has not mapped a specific plan, advisers on his transition team said reining in derivatives would be one of the biggest and most complicated parts of that effort.


Wall Street Journal:


Is deregulation to blame? – by Reason Magazine

2) The Commodity Futures Modernization Act of 2000 guaranteed that high-risk tools such as credit default swaps remained unregulated, opting instead to encourage a “self-regulation” that neverhappened.

In late September, Securities and Exchange Commission (SEC) Chairman Christopher Cox estimated the worldwide market in credit default swaps —pieces of paper insuring against the default of various financial instruments, especially mortgage securities— at $58 trillion, compared with $600 billion in the first half of 2001. This is a notional value- only a small fraction of that amount has actually changed hands in the market. But the astounding growth of these instruments contributed to the over-leveraging of nearly all financial institutions.

In the late 1990s, the fight over these and other exotic new derivatives pitted a committed regulator named Brooksley E. Born, head of the Commodity Futures Trading Commission, against the powerhouse triumvirate of Federal Reserve Chairman Alan Greenspan, Treasury Secretary Robert E. Rubin, and Securities and Exchange Commission Chairman Arthur Levitt Jr. Unsurprisingly, Greenspan, Rubin, and Levitt won. The result was the Commodity Futures Modernization Act of 2000, which gave the SEC only limited anti-fraud oversight of swaps and otherwise relied on industry self-regulation. The Washington Post has closely chronicled the clash, concluding that “derivatives did not trigger what has erupted into the biggest economic crisis since the Great Depression. But their proliferation, and the uncertainty about their real values, accelerated the recent collapses of the nation’s venerable investment houses and magnified the panic that has since crippled the global financial system.” In other words: The absence of a regulation didn’t cause the crisis, but it may have exacerbated it.

Part of the problem was a technicality. Instruments such as credit default swaps aren’t quite the same thing as futures, and therefore do not fall under the Commodity Commission’s purview. But the real issue was that Greenspan, Rubin, and Levitt were concerned that the sight of important figures in the financial world publicly warring over the legality and appropriate uses of the derivatives could itself create dangerous instability. The 2000 law left clearing-house and insurance roles to self-regulation. Without a clearinghouse, the market for credit default swaps was opaque, and no one ever really knew how extensive or how worthless the derivatives were.

In congressional testimony on October 23, Greenspan seems to have admitted error: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” he told the House Committee on Oversight and Government Reform. But Greenspan still wasn’t convinced that regulation is the solution: “Whatever regulatory changes are made, they will pale in comparison to the change already evident in today’s markets,” he said at the same event. “Those markets for an indefinite future will be far more restrained than would any currently contemplated new regulatory regime.”

Previously: New SEC Chief


CFTC’s Concept Release on the Appropriate Regulatory Treatment of Event Contracts&#8230- notably how they define &#8220-event markets&#8221-, how they are going to extend their &#8220-exemption&#8221- to other IEM-like prediction exchanges, and how they framed their questions to the public.

– American Enterprise Institute’s proposals to legalize the real-money prediction markets in the United States of America

Barack Obama has chosen Mary Schapiro, chief executive of a non-governmental regulator for securities firms (Financial Industry Regulatory Authority), to chair the Securities and Exchange Commission.

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What a great pick.

Out of the gate, Ms. Schapiro faces potential controversy. In 2001 she appointed Mark Madoff, son of disgraced financier Bernard Madoff, to the board of the National Adjudicatory Council, the national committee that reviews initial decisions rendered in Finra disciplinary and membership proceedings. Both sons of Mr. Madoff have denied any involvement in the massive Ponzi scheme their father has been accused of running.

What a visionary regulator: inviting the fox inside the chicken house, that&#8217-s clever, indeed.

Jason Ruspini, will Barack Obama replace the CFTC head, too?

The Case for Decrimininalization of Prediction Markets

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[This article is cross-posted from Major Wager.]

A recent article in the prestigious academic journal Science (May 16, 2008, Vol 320, p. 877-8) once again makes the case for regulated prediction markets, more commonly known as &#8220-betting exchanges&#8221- to online gamblers. The authors make the case that such markets are useful in forecasting future events with less error than traditional measures such as polling. This argument is hard to ignore, with the authors including 21 top economists from such esteemed institutions as Yale, Stanford, Berkeley, and the University of Pennsylvania. Notable among the authors is Justin Wolfers from the Wharton School of business at UPenn, an economist who has gained notoriety in gambling circles due to his work on such topics as NBA referee bias (highlighted in a May 2008 article from MajorWager: http://www.majorwager.com/index.cfm?page=27&amp-show_column=660).

The concept behind using prediction markets as a decision-making tool is simple. &#8220-Shares&#8221- are made available on an open market, and the participants use their capital (and the promise of profits) to make predictions on future events, which is incorporated into the share price. In general, information tends to be widely dispersed, and a market allows wide-ranging opinions to be gathered and consolidated into a market-wide prediction. In other words, an infinite amount of opinions can be aggregated, and an open market with potential for profit provides an incentive for individuals to make their opinions publicly known.

Prediction markets always get more than their fair share of press near the end of the 4-year U.S. Presidential election cycle. The Iowa Electronics Market, housed at the University of Iowa, is perhaps the most well-known. The authors of the Science paper show that, in the week immediately preceding the Presidential elections from 1988 through 2000, the Iowa Electronic Markets erred by an average of only 1.5 percentage points from the actual vote results, while the traditional Gallup poll was off by 2.1%. Numerous other studies have shown the superiority of markets compared to other forecasting tools.

Of course, there have been some dust-ups regarding prediction markets in the past, most notably the &#8220-terrorist strike market&#8221-, unveiled a little too close to 9/11 to be palatable to the general public. The official name was the &#8220-Policy Analysis Market&#8220-, and it was established by the Pentagon to act as a prediction market for Middle East political events. It was quickly scuttled after heated comments from U.S. Senators, calling it &#8220-grotesque&#8221- and &#8220-stupid&#8221-, due to the perception of using catastrophic events such as assassinations as profit-making tools. Regardless of its political correctness (and the misinformed opinions of a few politicians), such a prediction market still holds value as a glimpse into the collective mindset of everyone with an understanding of political currents in the region. Utilizing such a prediction market as a component of foreign policy decisions may have ultimately spared the U.S. much grief in Iraq.

In recent years, prediction markets have grown beyond academic and government roles. Dublin-based InTrade is rapidly growing and provides many more options than the Iowa Electronic Markets. Others such as MatchBook have focused more on sporting contests, but provide coverage of other events as demand calls. Of course, those outside the U.S. have access to the largest betting exchange of them all, the massive European markets of BetFair. The success of these exchanges speaks to the public interest and feasibility of prediction markets.

One factor holding back the growth of online prediction markets is their close association with the quasi-legal world of sports betting and internet casinos. InTrade has been fairly proactive in this regard, spinning off from Tradesports to clean up its corporate slate, but it is still knee-deep in the legal sludge surrounding offshore &#8220-gambling&#8221-. All have to deal with the legal and financial hurdles of operating offshore.

The authors of the Science paper propose that clarification of internet gambling laws is needed to exploit the benefits of prediction markets within the United States. Clearly, the Unlawful Internet Gambling Enforcement Act (UIGEA) of 2006 is one such mechanism restricting the widespread use of prediction markets. Another is the Commodity Futures Trading Commission (CFTC), the regulatory agency which oversees futures markets in the U.S. The CFTC has provided a &#8220-no-action letter&#8221- to the Iowa Electronic Markets, an assurance that they will not seek any enforcement action against the exchange. However, this protection is not absolute and may not trump state and federal law if challenged. The Science authors propose a number of legal reforms which will allow prediction markets to begin to gain acceptance within the U.S. financial regulatory structure.

By no means does the Science article condone large-scale public markets, at least not initially. They take a (typically academic) conservative approach, recommending new legal framework to allow for the establishment of small markets with limited scope so as to evaluate the promise and use of prediction markets. But baby steps are going to be a necessity in the growth and acceptance of regulated public markets.

Clearly, there are negative aspects to financial markets, and regulation certainly has its place. Bear Sterns, Enron, the S&amp-L scandal of the 80s, and the current housing bubble all caused tremendous loss of wealth resulting from missteps in the financial markets. The current oil crisis is due at least in part to speculation, leading to the introduction of no less than 9 separate bills in the U.S. Congress seeking tougher regulation over the trading of commodities. However, the existence of problems in the financial markets does not necessitate their dissolution. Likewise, prediction markets are sure to encounter bumps in the road, but their utility should far outweigh the risks.

Should prediction markets be legalized in the U.S.? Almost certainly. They would have benefit across numerous industries, from business decisions to political policies to financial forecasting. Unfortunately, this would require building an unlikely bridge over the Puritanical moral moat placed around gambling in the U.S. But there is no inherent difference in betting on who will win in an election than what the price of oil will be in 6 months, or what the S&amp-P 500 will close at on a particular date. Distancing prediction markets from &#8220-illegal&#8221- gambling, and instead likening them to regulated financial markets, will be a necessary first step towards broader acceptance.

The academic groundwork on prediction markets has already been laid, and offshore exchanges have begun to turn these concepts into functioning businesses. As these markets grow and begin incorporating more diverse opinions, we can expect their success rate at predicting the future to only grow. To restrict such a promising tool simply due to its perception that it is a gambling outlet is silly indeed.

Jay Graziani

[This article is cross-posted from Major Wager.]