Risk Markets And Politics

Sunday, October 15, 2006

The Bottom-up Approach to Legal Prediction Markets

As hoped, the gambling crackdown is beginning to energize efforts that will eventually lead to legal prediction markets in the United States. As expected, some call for CFTC regulation, while others would prefer an exemption of the kind currently protecting horse-racing and fantasy sports, while libertarians tend to favor legal and regulated internet gambling in general.

The most flexible outcomes are also the most expensive ones, at least if one discounts the option of openly starting a real-money exchange and then relying on a combination of the skill/chance distinction and one's good intentions to receive a favorable ruling. The CFTC option would be the most restrictive, but the least expensive since it might not require any lobbying. Proponents of the other two options are left to wonder where the money behind a lobby will come from. Prediction markets have apparently not yet "made millions in decision-value" for anyone. The overseas exchanges and books might have made millions in commissions and spreads, but the US government considers them illegal, and their US clients have little net profit to speak of. In terms of a more general gambling legalization, real prediction market allies actually seem to be few and far between. The Poker Players Alliance is going its own way, turning its back on skill-based contests with appreciable social benefits. American casinos don't seem as hostile as they once were, but remain on the fence. Unfortunately, there is plenty of money on the opposite side, including all professional sports leagues.

Tom W. Bell's suggestion that lobbying campaigns take place at the state level could therefore be helpful. Efforts that would be ineffectively small at the federal level could be marshaled and directed at the most favorable states. The markets would only be legally open to those states' residents, and the operators of the markets should make the good-faith practice of blocking clients from states were gambling is clearly illegal. But there is reason to suspect that if such a law is passed in one state, others will follow, in part from precedent, in part as a tax-dollar rush. At some point, a network effect will help the process along. Within a couple of years, a "confederation" of states where prediction markets are legal could be bootstrapped.

Leaving aside the possibility that a federal backlash might remove the safe-harbor section of the Wire Act described by Tom Bell, what are the most propitious states for such a plan? States that lack casinos are the natural places to start in order to avoid opposing interests. Using the summaries provided by gambling-law-us.com, what follows is a list of states that have no commercial or tribal gambling industries, no explicit law against online gambling, and whose definition of gambling at least questionably applies the dominant factor test of chance over skill — at least according to gambling-law-us.com. In order of population: Pennsylvania(p), Ohio (f), Georgia(d,f,p), Virginia (f), Massachusetts(p), Tennessee(d,f), South Carolina(p), Kentucky(f), New Hampshire(d,f), Hawaii(d,f) and Vermont.

By my own reading of the appropriate laws, there are some unfortunate caveats:

d: The dominant factor test may not actually apply. Often the laws read as, "notwithstanding that skill of the contestants may also be a factor therein", or "dependent upon chance even though accompanied by some skill". Thus bets may be considered illegal even if skill is the dominant factor.

f: Aggravated gambling is a felony. "Aggravated" mainly applies to ongoing businesses that capture some fee for taking (or matching) bets. If the dominant factor test applies and the markets don't touch specifically prohibited subjects, this may not matter.

p: There are specific prohibitions against betting on a political election or nomination outcome (though not against betting on policy events).

There are doubtless many other issues that I am unaware of that will disqualify or reinforce some of these choices, including precedents and interpretations on the chance/skill distinction. There may also be good reasons for including some that were left out. For one thing, it can be argued that the sorts of markets we may be interested in will have a different clientele than the slot-machines and blackjack tables of traditional casinos, and so the lack of opposing interest criterion can be demoted. This is a headwind that prediction markets do not share with poker and the PPA.

That said, another danger to this plan is that national interests may intrude in those states where they currently have little presence, not to mention the federal government applying funding-related pressure. This sort of dynamic is surely in part responsible for the homogeneity of US state laws, but a more experimentalist regime in which laws meaningfully diverge would be more productive and beneficial to the nation in the long run.

To give-in to a sweeping analogy, from its very beginning, biological evolution is made possible by barriers. Barriers allow and promote diversity, which leads to the lucky strikes, the better ways of doing things.. that survive.

In any case, the good intentions of proponents of markets on science and policy claims should be clear, and they will no doubt be in contact with state Attorneys General offices in the coming months.

Monday, October 09, 2006

"All the iridescence of the beginning of the world"

The World Economic Forum dropped the United States from first to sixth place in the 2006-7 Global Competitiveness Report, released on September 26th. As Dave Altig points-out, America still holds the top position in microeconomic efficiency, and its downgrade results from its suggestively ominous yet difficult-to-interpret macroeconomic position. But microeconomic conditions include things like flexible regulation, and these factors are also beginning to show cracks in the United States.

More significant than the recent embarrassment of HR 4954, the Sarbanes Oxley Act of 2002, and specifically, section 404, has made it prohibitively expensive for companies to list their equities on US exchanges. The stringent auditing and corporate governance requirements imposed by Sarbanes Oxley helped to push 24 of the 25 largest initial public offerings to overseas exchanges in 2005 (though several were nationalized companies being locally privatized, and the list included Partygaming). Between 2003 and 2005, European exchanges went from listing 10% as many technology IPOs (greater than $15 million) as the US, to 93% as many. As of September 20th, this year has witnessed 17 IPOs totaling $6 billion on the New York and Nasdaq exchanges versus 59 totaling $16 billion on the London Stock Exchange. Optimists in the US seem to think that European and Asian exchanges will adapt similarly rigorous listing requirements. They are wrong. International and (hopefully) interstate competition will continue to punish bad laws.

And to quote F. Scott Fitzgerald again, "it had limits — from the tallest structure he saw for the first time that it faded out into the country on all sides, into an expanse of green and blue that alone was limitless."

Sunday, October 01, 2006

The "top" of the anti-gambling movement?

In the oh-so-very important crusade against internet gambling, Republican law-makers, led by Bill Frist and Jon Kyl, scrambled to include a version of the Unlawful Internet Gambling Enforcement Act in the Safe Port Act as the clock approached midnight on Friday. Ostensibly a defeat for proponents of online speculative markets, the passage may actually be a blessing in disguise and signal a weakening anti-gambling hand in the US. Consider these bright spots:

  • Only the section eliminating payments to online gambling establishments from US-based institutions was passed in Congress. The broken Wire Act of 1961 was not amended, and the legality of placing non-sports bets online is still ambiguously intact in most States.

  • The commercial banking sector and other financial institutions (which are far larger than the casino and gaming industries) have 270 days to cooperate with the law upon final passage. Because of the high cost of compliance, along with the risk of blocking lawful transactions, it is possible that the eventual procedures may lack effectiveness. Significantly, the prescribed regulations are in the hands of the Secretary of the Treasury and the Federal Reserve Board, who only have to "consult" with the US Attorney General. Since not blocking a restricted transaction is not in itself initially a criminal offense, and might only result in an injunction, it is not hard to imagine that consultations with financial institutions might actually carry more weight than those with the Attorney General. (The financial institutions must not, however, "own" "unlawful" gambling businesses, as we know that many in the past have, in the form of stock.)

  • Even if there is effective implementation of payment blocking, options such as NETeller (NLR.L), FirePay (FPA.L) or MoneyBookers are somewhat untouched by the legislation. In reality, little has changed for US traders. Overseas internet gambling companies will bear the main brunt of the legislation, as US clients may be reluctant to use alternative payment methods, and even if they do so in large numbers, gambling companies will then face increased counterparty risk. At least one alternative payment company might actually benefit from this law.

  • Opponents of online gambling are further disgraced. It was embarrassing enough that they were already catering to the interests of casinos, lotteries and exempted gambling interests in an almost cartoonish fashion. Now they also being called negligent in terms of national security. Anti-anti-gambling animus is growing.

  • There are rumors that "tax haven" nations such as Gibraltar and Antigua, among others, are considering legal action against the United States, which was already in violation of a previous WTO trade treaty ruling.

The most worrying section of the bill to some concerns Internet service providers and reads that enforcement, "be limited to the removal of, or disabling of access to, an online site violating section 5363, or a hypertext link to an online site violating such section, that resides on a computer server that such service controls or operates". The question is then: does "reside on a computer server" apply to "an online site", or, more generally, "access to" an online site? The latter interpretation is far stronger and would suggest that ISPs can be prevented from redirecting connections to gambling sites, but I think enforcement of that interpretation would be highly contested, and comes back to the central difficulty of internet regulation. Since UIGEA principally makes the acceptance of gambling payments illegal, and overseas companies are not governed by US code, the entire bill is arguably devoid of force with respect to them. Financial institutions made to comply with the law might say as much in the 270-day window. The venal nature of exemptions for favored gambling interests will only help to undermine the law one way or another.

10/3/06 Update: The market strenuously disagrees with my appraisal of the alternative payment companies like NETeller and Firepay, but it is unlikely that such companies will be specifically targeted in the recommended procedures of The Secretary of the Treasury and The Federal Reserve Board —— after all, they also process non-gambling transactions. This leaves the companies with a choice: respect US law though they are (arguably) not governed by it, or take the opportunity to gain market-share in a vacuum of sorts. I would guess that at least one will take the latter path. The market is instead saying that they will be somehow targeted, or meekly fold like 888 and Partygaming (who the DOJ already considered to be in violation of the Wire Act, not to mention tax evasion). NETeller's statement gives no indication that they will be voluntarily closing-off their US business. As Gambling911 reports, 888 and Partygaming seem to be pursuing buyout strategies at this point. Yesterday, considering that each group was down about 60%, I suggested a spread trade (long the processors, short the casinos & books) on Patri Friedman's journal that is working out nicely so far.

Meanwhile, The Poker Players Alliance is taking an increasingly parochial viewpoint. The organization's president was recently quoted as saying, "Our desire is to achieve the same type of exemption from legislation that other interests have received (Horseracing, Lotteries, and Fantasy Sports). [...] This is our most immediate short-term goal" Well, everyone is a special interest of course, but perhaps they ought to rethink that goal as it won't gain them any friends outside of their immediate sphere. Perhaps a more robust, longer-term goal would be appropriate considering that in the "short-term", poker is a game of chance.

Speaking of gamers, I notice from my access logs that a certain three-letter agency read, among other things, my post on the gambling that might be taking place in virtual locales operated in the United States. Yet something else to keep an eye on.