Why the Government Doesn’t Want You to Bet Money on Elections

If the federal government has its way, soon you won’t be able to bet on the outcome of certain events, such as political elections.

The Commodity Futures Trading Commission intends to withdraw authorization that allows a popular venue for placing such bets, called PredictIt, to operate.

One might think no public benefit is gained by gambling on elections. The CFTC appears to agree, with a long history of looking askance at markets offering this service to the public. But more is at stake than mere gambling.

Business Protection

While markets like PredictIt meet the demand of those who want to speculate on political outcomes, they also accommodate businesses that seek to hedge against adverse consequences from such outcomes.

Suppose you’re a manufacturer operating in today’s marketplace. You face numerous challenges and risks—some you may try to mitigate, and some you can’t.

For example, if your business is subject to interest rate, currency, or commodity price risk, you can hedge against any of these risks in the futures, options, or swap markets. Although less than perfect, these financial markets allow you to protect your business to varying degrees from many of the risks you face in the marketplace.

Managing Event Risk

But while you may be able to protect yourself from market risk, you generally can’t do so with respect to other types of risk, such as those associated with the outcome of certain events—“event risk.” Yet events can have just as profound effect on your bottom line as changes in the market.

When British Prime Minister Harold Macmillan was once asked about the greatest challenge he faced as a leader of that nation, he famously replied, “Events, dear boy, events.” Today, there is little opportunity to effectively respond to events that affect individuals and businesses.

That opportunity exists only on a few exchanges that specialize in offering contracts to speculate and hedge against certain events, such as the outcome of political elections.

These markets, often referred to as “political event markets” or “prediction markets,” operate trading platforms that allow participants to buy and sell options predicting whether specific future events will occur, and profit if they are right.

CFTC Undermines Hedging

Historically, the CFTC, which has regulatory authority over such markets, has taken a restrictive stance toward their establishment and operation.

While the agency has let some operate, albeit under restrictive conditions, it has not allowed others to do so. Even for the ones it has authorized, the CFTC has been known to take away the punch bowl just as it has gained widespread acceptance and popularity.

In 2012, the commission shut down one such venue called InTrade, and today threatens to shut down PredictIt and other platforms, notwithstanding their popularity with the American public and their utility to the academic, political, and journalistic communities.

This restriction is a shame, because it prevents effectively hedging against political event risk in the US. It also deprives the markets of a predictive tool—one that is usually more accurate than traditional polling.

Allow Predictive Markets

More important, this restrictive posture deprives the public from access to what one scholar described as the important “informational value” of “aggregate[ing] the beliefs of market participants” in a way that political polls and other methods of measuring attitudes “cannot replicate.”

Given the express bias of regulators against anything resembling gambling, this attitude may be understandable. But it also conflicts with the purpose of modern financial derivatives markets, which is to allow businesses and even consumers the means to protect themselves against risk of loss from sudden changes in the marketplace.

We all know that elections have consequences, including a firm’s ability to maintain profitability, or even its ability to stay in business. One of the greatest risks businesses increasingly face is loss resulting from the winds of political change.

Political risk is just as real as spikes in energy prices or interest rates. While the economic utility of event or predictive markets has always been subject to debate, it makes sense to allow market participants to hedge against risks emanating from events as much as they can against other market risks.

The CFTC should recognize the importance of fostering innovative market tools to meet the risk-management needs of firms that operate in today’s markets and the importance of adjusting regulations to meet such needs.

Rather than view such activities solely as matters of regulatory compliance, the CFTC should approach them as an opportunity to provide market participants in this sector with access to tools that participants in other sectors of the economy enjoy.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Robert Zwirb is an attorney who has advised market participants on financial regulatory issues. He has served as counsel to a Wall Street law firm, as well as to two former chairmen of the Commodity Futures Trading Commission.