April 4, 2012

The CFTC and Political Reality

Hester Peirce

Former Senior Research Fellow
Summary

The government is an active participant in the economy. Elections have consequences for the economy and the individuals and companies that make up the economy. The recent passage of the STOCK Act reminded us of this fact.

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Just as the campaigning for November’s general election is about to get off the ground, the Commodity Futures Trading Commission shut down one form of political speculation.  Earlier this week, the CFTC told the North American Derivatives Exchange that it is not allowed to offer political event contracts.  NADEX had planned to allow investors to enter into financial contracts based upon who wins the Presidential election and majority control of the Senate and House of Representatives.  The CFTC’s move ignores market and political realities.

The CFTC does not believe that political event contracts are legitimate tools for hedging business risk because elections don’t have predictable economic consequences.  The CFTC also worries that they would undermine the integrity of elections.  Voters, driven by their financial interests, might select candidates “even when such a vote may be contrary to the voter’s political views of such candidates.” 

Yet these findings do not comport with Washington realities.  A company that makes solar panels or windmills might want to hedge the risk that it faces if the election does not produce politicians likely to grant it subsidies.  A defense contractor might want to hedge the risk that doves get elected instead of hawks.  For that matter, a grandmother might want to hedge her risk that the elections will produce politicians who will shrink her social security check. 

Similarly, the notion that voters’ “political views” are driven solely by their ideological beliefs runs counter to reality.  The aforementioned grandmother might vote for a candidate who does not share her views on foreign policy, because her financial interest in receiving a large social security check might trump her ideological beliefs about international relations. 

In any case, blocking NADEX will not completely stop politically based futures trading.  The Iowa Electronic Markets, which are run by academics at the University of Iowa’s business school, offer several futures markets based on political events with the CFTC staff’s blessing.  Another market, Intrade, which operates out of Ireland without a CFTC blessing, lets traders put their money behind their political predictions.

The government is an active participant in the economy.  Elections have consequences for the economy and the individuals and companies that make up the economy.  The recent passage of the STOCK Act reminded us of this fact.  The CFTC cannot change that political reality by banning political event contracts.