This content is from: Portfolio

Afraid of What We Know

One surefire way for Washington to put on a show of political force is to hold hearings.

One surefire way for official Washington to put on a show of political force is to hold hearings. It’s a venerable tradition that has produced such recent spectacles as a Senate investigating committee grilling Goldman Sachs Group executives and the Financial Crisis Inquiry Commission trying to get to the bottom of what went wrong in 2007 and 2008.

Lamentably lost in all that hoopla — not to mention continuing inquiries into the Gulf of Mexico oil spill — was the May 19 open meeting of the U.S. Commodity Futures Trading Commission.

The event was blandly titled “Consideration of the Trading of Contracts Based on Motion Picture Box Office Receipts,” and its purpose was to review two financial firms’ proposals to trade derivatives on the anticipated earnings of movies. But the proceedings revealed as much as any other Washington drama about the unpredictable intersection of politics and finance and how it can make hash out of reasonable and even demonstrably useful business innovations.

The CFTC in March approved two new designated contract markets: Cantor Futures Exchange and Media Derivatives (MDEX) — the former an affiliate of New York–based Cantor Fitzgerald, the latter a three-year-old Scottsdale, Arizona, venture that is also known as Trend Exchange. After getting their designations, the firms had to seek approval for their respective box-office futures contracts. Led by chairman Gary Gensler, the CFTC offered them a chance to press their case — or, more to the point, debate it — with A. Robert Pisano, president and interim CEO of a major Washington power player, the Motion Picture Association of America.

Pisano had taken every opportunity to try to scuttle the proposals. Claiming the backing of major studios and independent producers representing 95 percent of the film industry’s output, Pisano objects most strenuously to the “synthetic, artificial” nature of the proposed futures, which he says are tantamount to “gambling” and threaten to distort the workings of an industry whose “every product is unique and not a commodity.” Cautions Pisano,“We don’t want to repeat in our industry what happened in the mortgage industry and others hurt by the financial crisis.”

Richard Jaycobs, president of Cantor Futures Exchange, and Robert Swagger, chairman and CEO of MDEX, gamely explained to the commission that futures markets allow risks to be measured and hedged. Jaycobs said the trading would mean new transparency and bring financing sources, both institutional and individual, into “an extraordinarily risky business.” Swagger said care was taken to eliminate “excessive speculation.”

The CFTC issued its first approval, on MDEX’s contract, in a 3-2 vote on June 14. But the broader antagonism enunciated by Pisano resulted in an amendment to the Senate’s financial reform bill — ultimately adopted in the final legislation — to prohibit the box-office contracts as just another form of undesirable derivatives speculation. Washington quashed an innovation of this sort in 2003, when the U.S. Defense Department was developing a futures-like prediction market. Policy experts and analysts would be invited to “invest” in alternative scenarios. Those bets would serve as inputs into national security and defense policy. When word got out that one of those scenarios would be a terrorist attack on U.S. soil, lawmakers railed against the opportunity for some investors to seek to profit from “terrorism futures.” The project was shut down.

No such outcry has afflicted Iowa Electronic Markets, known for its election forecasts, or Ireland-based Intrade, which makes markets in everything from sporting events to military troop levels. They have uncanny records of accuracy that reflect “the wisdom of crowds,” to use the title of a 2004 book by James Surowiecki. Now a New Yorker magazine columnist, Surowiecki recently wrote, “Markets work best when there’s lots of information available and a historical track record to go on; they excel at predicting things like horse races, election outcomes and box-office results.”

Cantor — which runs an existing market, Hollywood Stock Exchange, with play money — and MDEX are selling a particular, proven brand of market-based predictability. The MPAA isn’t buying their pitch, but some big corporations — Best Buy Co., Electronic Arts and Hallmark Cards, to name a few — have embraced futures market models. One system with a Fortune 500 clientele, Crowdcast, aggregates participants’ “collective intelligence.” Google, which has run an in-house prediction market since 2005, in May bought a stake in another predictive platform, Recorded Future. These organizations are using market techniques for reality checks and scenario planning — essential exercises in an increasingly volatile world. Others just don’t want to go there.

Jeffrey Kutler is editor-in-chief of Risk Professional magazine, published by the Global Association of Risk Professionals.

Related Content