Risk Markets And Politics

Tuesday, March 14, 2006

Some Benefits of Legislation-Linked Derivatives


Though tiny and not significant in a technical sense, one of the more exciting data sets to become public of late is Randall "Duke" Cunningham's "bribe menu". Cunningham, a former member of Congress where he "served" as a member of a defense appropriations subcommittee from 1998 to 2005, redirected more than $150 million in defense contracts to a single company in exchange for over $1 million in cash and other gifts. The data set in question is a list of price quotes for favors, depicted to the right and detailed below:

Defense ContractPrice
$16 Million$140,000 + Luxury Yacht ("BT" = "Boat")
$16-$20 MillionAdd $50,000 for each $1 million above $16 million
$20 Million +Add $25,000 for each $1 million above $20 million


This is a fascinating look into the market for congressional favors. Alex Tabarrok was disturbed by how low the prices were, noting that they implied competition among congressional suppliers. The curve of this particular price scale along with the inclusion of a non-cash gift could mean that supply was only limited by money-laundering capacity. From the standpoint of the favor buyers, risking the illegal transaction provided phenomenal returns.

Returns are presumably much lower for legal campaign contributions of the sort one finds on Opensecrets.org. The outcome of legal contribution is uncertain and indirect, and some of it is probably downright futile. The lack of association between contributions and specific pieces of legislation (or contract awards) suggests that the process may be inefficient for the contributors. In many cases, prediction markets should be a more reliable and precise way for (special) interests to manage the risks of such outcomes. Promoting the creation of positive, pro-agenda legislation might still involve contributions, but when bills surface that are unfavorable to a certain group, legislation-linked derivatives will be more efficient than the current nebulous system. Actually, insofar as the current system is "efficient" for special interests, it approaches straightforward favor-buying; legislation-linked derivatives should reduce the demand for congressional favors. Sure, they could lead to a new market in congressional inside information, but this outcome would be less likely to distort the content of decisions made on the Hill.

Such markets would furthermore enjoy the advantage of natural counterparties. Perhaps competing special interests with opposite hedging needs could trade with one another, thereby partially disintermediating the government in their private affairs. More generally, any time a tax or subsidy is in play, the natural counterparties are the directly affected interest group on one side and every other taxpayer on the other side. Whenever a tax-break or subsidy is awarded to a special interest, this in itself implies an additional tax burden on every other taxpayer. The existence of markets to hedge such events from either side would, among other benefits, frame the operation of the government in a way that would encourage greater fiscal discipline.

4 Comments:

  • I think you might be on to something here, with only one potential problem. I think lots of people like the current system as it is, with the graft and backroom deals. The system you propose would be more efficient, but would it be more popular.

    I read a story a few years back about by a SF writer Michael Swanwick, where one of the characters had made his fortune creating 'lawsuit futures'. At the time, I thought this was a crazy idea, but now, I am not so sure. Parties who are naturally long and short, people who will be impacted without a potential to hedge, informed observers, and occasional media frenzy make this idea less than crazy.

    By Blogger Mickslam, at 1:11 PM  

  • Thanks for the Swanwick pointer. I'll check it out.

    I don't know if people like the current system per se.. maybe insofar as there is graft, etc people are somehow more comfortable not knowing about it.

    Most of the objections to legislation-linked derivatives seem to be of this touchy-feely sort: "Well, that just doesn't seem right". People blanch and ask, "Isn't there a law against that? No?" or more to the point conclude, "Congress would never allow it". Perhaps, but there are enough benefits that I think these contracts will catch-on somewhere in the not-too-distant future.

    By Blogger Jason Ruspini, at 10:24 AM  

  • is this type of article taking the piss? as a way of showing up corruption in Congress?

    to actually allow a 'derivatives market' in congress corruption would be to sanction and endorse it, when it is in fact potentially illegal behaviour. the american congress is known to be one of the most heavily corrupted bodies politic going, but shouldn't the corruption be stamped out rather than opening a 'market' on it? in fact, why do people assume everything must have a 'market' solution?

    By Blogger Sean Reynolds, at 9:10 AM  

  • Sean, There is no proposal for a market in corruption. The idea is that markets linked to the outcome of legislation will actually decrease corruption by decreasing the demand for favors. Now, this is certainly arguable, especially if it is lawful for legislators to trade in such markets. But aside from insider trading fears, the burden is on critics to point-out specific dangers and possible unintended side-effects. Yes, this sort of market doesn't feel right to many people, but I am not joking, or as you put it "taking the piss". Also, I am not of the opinion that markets are always the answer, especially where force is concerned. Cheers.

    By Blogger Jason Ruspini, at 6:38 PM  

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