Risk Markets And Politics

Sunday, October 30, 2005

Dorgan vs. Markets

Senator Byron Dorgan seems to be an enemy of markets. "Better to be a friend of people", his supporters will shout. Since I am careful not to mistake means for ends, I agree, but Dorgan now has a history of seizing upon ephemeral opportunities for political hay-making at the expense of sane economic policy and financial innovation. Dorgan's abusive attitude towards markets may accidentally hurt citizens, subverting his intended goals.

I and many others have, intellectually if not effectively, defended the central concepts of PAM against the Senator's attack. I have gone on to argue that legislation-linked futures markets would not suffer from the same major difficulties of prediction markets linked to events such as terrorism and coup d'etats. The basic difference: in the latter cases the "insiders" and their agents are inherently lawless, while legislators are lawful. Um, that is, it would be quite something if legislators argued that they couldn't be trusted as insiders in the case of legislative prediction markets.

If there were a prediction market in place linked to Dorgan's proposed windfall tax, energy companies would have the recourse of insuring part of their potentially affected profits. Senator Dorgan claims there is $7 billion per month in windfall profit, and wants half of it. Philip Verleger, an economist and senior fellow at the Institute for International Economics, calculates that even with exploration costs offsetting part of any windfall tax, the tax could raise $3 billion to $4 billion a year (over 3 years) from each of the three or four biggest oil companies. This is potentially a far more sizable market than anything yet seen on the online prediction exchanges such as Tradesports, and since it is essentially an insurance market, participation will be compelled in ways lacking from markets that are more purely "betting" markets, such as the SCOTUS contracts.

The example isn't necessary, but as we saw with the Miers non-arbitrage on Tradesports, the wording beyond the contract titles is critical. Legislation-linked futures will most likely predict suitably general-yet-specific concepts being fully passed into law by a certain date — not specific bills being passed in specific houses, under threat of veto, etc.

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