ASIC Drives a Stake into Already Dead Prediction Markets

And why ‘pale, male and stale’ is endogenous to ‘old, rich and retired’

Some readers might recall Intrade, a prediction market that offered all manner of contracts ranging from the daily close on the Dow to the outcome of US Presidential elections and the timing of North Korean missile launches. They also offered contracts for US economic data releases. The latter tended to be somewhat illiquid markets with wide spreads, although you could make money by being a liquidity-provider in those markets. I was at one time the entirety of short interest in the contract on Malcolm Turnbull’s first-time leadership of the Liberal Party (sorry not sorry to the people on the other side of that trade). The implied probabilities thrown off by these contracts were often highly informative.

Needless to say, US regulators did not like Intrade. The CFTC effectively closed the market to US customers in December 2012, all but destroying the business, which then closed in March 2013. This is not the only prediction market to fall victim to regulation. The New Zealand-based market iPredict closed due to its inability to obtain a regulatory exemption from AML laws. As recent experience in Australia shows, financial institutions with multi-billion dollar market caps find it almost impossible to comply with these laws, despite devoting enormous resources to doing so. The law is written to be broken. A small prediction market had no chance of meeting this compliance burden. Other prediction markets survive, although these are often toy or educational markets that receive regulatory forbearance so long as they don’t pretend to be serious markets. There is an explosion of prediction markets in blockchain space, but many of the these are inaccessible and illiquid.

ASIC has just issued a product intervention order that bans one of the most common forms of prediction market contract, the binary option. The order has extra-territorial effect. If you are an Australian retail investor and have an account with a binary options provider in Australia or overseas, you will soon be told they are closing your account, if they haven’t done so already. If Intrade or iPredict were still around, they would now be off-limits to Australians. In a former life, I was involved in lobbying against giving ASIC such sweeping product intervention powers, noting their potential to stifle financial innovation. We weren’t wrong.

ASIC’s complaint against binary options is that 80% of people trading them lose money. Of course, this would be an argument for banning almost any exchange-traded or OTC derivative. If a majority of people could make money trading a particular instrument, we would all be doing it. But it also fundamentally misunderstands the role of financial markets. Markets are not there to prevent people losing money. The purpose of markets is to discover prices and reveal tacit knowledge. The social benefit from price discovery is enormous.

You might question whether these social benefits are large in the case of small OTC markets in which retail clients are largely betting against each other. Yet in March-April last year, the very illiquid binary options on US initial unemployment claims listed on the North American Derivatives Exchange were notable for accurately predicting much larger losses in employment than the median professional forecaster. Even averaging the market-maker’s bid-offer was informative. The point is, you don’t know what information you lose when you shut-down markets, especially those markets that offer shorting opportunities not otherwise available to retail clients. I suspect many retail investors use OTC binaries and CFDs to hedge long equity exposures which they would otherwise be forced to liquidate.

In my paper on Reforming Australian Monetary Policy, I call on ASIC to create a permissive regulatory framework for public interest prediction markets, partly with a view to facilitating non-exchange-traded OTC and DLT-based NGDP derivatives. As you might have guessed, this call was somewhat rhetorical, but supported my broader point that regulators should mandate a market in nominal GDP futures given the social desirability of this information and the barriers (mostly regulatory) to the creation of such a market. If you think the information generated by such a market would be a useful input into public policy with large social benefits, then you should be prepared to incur some costs to get it. But ASIC’s product intervention order shows it has other priorities. I use to joke that ASIC’s regulatory sandbox was there to give them a heads-up on what products they would ban next.

If you want the information potentially available from public interest prediction markets, it is probably a good idea not to ban the instruments mostly commonly used to transact in those markets.

Shane Wright’s stories on the RBA have generated quite a bit of controversary, not least on the part of those who saw them as either unfair, or worse still, a hatchet job. But the case for the defence was unconvincing. Some wanted to highlight the role of fiscal policy, shifting blame for macroeconomic outcomes to the government. You may notice the same critics don’t like the government much anyway. In fact, Australia has seen one of the largest fiscal responses to the pandemic of any comparable economy, if not the largest. The pre-pandemic fiscal consolidation was spread over a decade and barely put the budget into surplus. The RBA had no problem hitting its inflation target alongside a decade of budget surpluses from 1998-2008. The imbalance in the mix of monetary and fiscal policy in the pandemic response gave rise to serious open economy crowding-out effects, which the RBA conceded when it noted that the AUD has risen because other central banks had done more. Note how well the US dollar is now doing with additional fiscal stimulus behind it.

As to the piece being a hatchet job, we noted last week that almost everyone involved had strong incentives not to participate in that story, which goes to another complaint. Gabby D’Souza noted the lack of diversity in the people quoted, complaining that they were ‘male, pale and stale.’

Like many of the other people quoted, I know Gabby personally and we all respect each other, so no offense taken. But the ‘male, stale, pale’ problem is really the one I discussed last week, which is that very few people are free to speak-out on this issue, regardless of gender or other markers of diversity. The remarkable thing about that story was that 11 people of any description were prepared to go on the public record. Indeed, that was the story.

Had the story run any time from 2014 to 2017, my job would have precluded me from being quoted, although I would have provided background if asked. In another role, the head of a regulatory agency contacted members of the board of the organisation I worked for to complain about things I had said publicly about the agency’s track record in the courts. Fortunately, my then boss and the board viewed that as me doing the job I was paid to do.

Peter Tulip had to resign from the Bank in order to speak out. No one apart from his current employer is going to reward Peter for his contribution. One the Bank’s most severe critics is a financial market economist who blogs anonymously (even I don’t know their identity). In New Zealand, a Reserve Bank Governor took-up his dislike of the commentary of a senior market economist with the CEO of the financial institution that employed him. While I doubt that would happen here, I don’t see market economists queuing up to put that to the test. Ask Saul Eslake what it’s like to be chief economist at a bank and make mildly critical comments of federal government policy to which the Treasurer takes umbrage.

Some of the people quoted are old, rich and retired or nearly retired (even I’m just a few years away from being able to draw-down super) and so no longer need to worry about what other people might think. The gender and other diversity issues are partly endogenous to age. The lack of diversity is partly a legacy issue.

I was always inspired by the willingness of my former CIS colleague Helen Hughes to speak truth to power and try to live up to the example she set. Helen didn’t believe in the hereafter, but I still hear her voice admonishing my work because I heard it so often when she was alive. She could be harsh, but also supportive and encouraging. Before I was employed at CIS, I had to run the gauntlet of lunch at her home in Double Bay. Apparently, I passed. While I doubt it made much difference to her, a World Bank pension didn’t hurt either. If Mardi Dungey had not tragically lost her life, I would have recommended Shane speak to her. I cited one of her publications in two recent publications of my own (I’m not sure what she would have said, but I would have respected and engaged with her views).

While Gabby’s complaint is entirely legitimate, in this case, I think a partial free pass on diversity was defensible, but only to tell an important story where too many people are either unable or unwilling to speak out, regardless of background. That is not to say we can’t all do better on diversity more generally.