Duane Hoffmann / MSNBC
By Mike Brunker Projects Team editor
updated 9/10/2004 8:30:54 AM ET 2004-09-10T12:30:54

While public opinion polls regularly generate headlines during the election season, a different type of predictor is quietly developing a devoted following among those who are bullish on Bush or accumulating Kerry.  Known as “political futures” markets, the online oracles rely on the forces of capitalism to sort out political races by enabling “traders” to purchase contracts on candidates or election outcomes, much as they would buy corn or soybean futures on a commodities exchange.

For example, someone who liked President Bush’s chances of winning re-election could  purchase a “contract” forecasting a Bush victory on Nov. 2, which on Friday morning was trading at 61.4 units worth 10 cents each, or a total price of $6.14, on Intrade.com. On Nov. 2, the contract will have a value of either 100 units ($10) if Bush wins or nothing if he is vanquished by his Democratic rival, Sen. John Kerry.

If the pick was Kerry, each contract would cost 39 units, or $3.90, and pay either $10 or nothing once the election is decided.

Purchasers holding contracts on either candidate also have the option of selling them before the election if they wish to either lock in profits or cut losses.

Intrade.com, which says that between 1,500 and 2,000 traders are active in its political markets each day, has no financial stake in the outcome since it simply skims a commission of 4 cents per contract. That amounts to a lot of pennies, however, as the site had $4.6 million in open interest in the Bush contract as of this week.

The numbers generated by the markets differ from polls in that the 61.4 for Bush does not indicate that he is expected to attract 61.4 percent of the vote. Rather, it indicates that the market rates him slightly better than a 3-2 favorite to win the election, even if only by one vote.

More accurate than polls?
In addition to offering traders the chance to make or lose money on the race for the White House – or a host of other races or “proposition bets” being offered – there is a growing body of evidence suggesting that the political futures markets offer a more accurate picture of political races than polls.

“It’s a lot different than a public opinion poll of likely voters, only about half of whom will actually vote and many of whom haven’t made up their minds,” said Michael Knesevitch, a spokesman for Intrade.com, an Irish company that is one of the leaders of the emerging commercial market for what is known as event trading in the United States. “We ask, ‘Who do you think will win?’ and then we ask the traders to back that opinion with risk capital.”

The markets work the same way that the pari-mutuel system works at the racetrack, where the crowd is better at picking winning horses than any individual handicapper, said Forrest Nelson, co-director of the Iowa Electronic Markets at the University of Iowa.

“It’s the wisdom-of-the-crowd argument,” said Nelson, an economics professor at the university’s  Henry B. Tippie College of Business, which has been running a political futures market since 1988. “No one person understands very much and the nature of their information is very different. (The markets) fail when there is no information out there or the traders don’t have access to the information. But if the information is out there and just spread around, the markets have a good chance of getting it right.”

Another reason that the futures markets have an edge over polls is that they react almost immediately to events on the campaign trail, said John Murray, a 38-year-old financial trader from Morris Plains, N.J., who buys and sells political contracts on Intrade.com, one of more than a dozen Web sites offering some sort of event futures trading.

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‘The market ... blew away the public opinion polls’
“One big example of that was the Democratic convention,” he said. “It’s conventional wisdom that there would be some sort of pop for Kerry, but the market began rallying for Bush before any public opinion polls (showing that Kerry didn’t get the expected ‘bounce’ in the polls). … The market just blew away the public opinion polls.”

In addition to serving as a political predictor, the markets are seen as having the potential for a variety of applications.

The theory was behind a political controversy last year involving the Policy Analysis Market, a Defense Department sponsored project that envisioned selling contracts on markets such as whether foreign leaders would be assassinated or certain governments overthrown. The project was canceled amid a flood of negative publicity that also led its architect, Adm. John Poindexter, to resign.

Commercial Web sites have filled the void to some extent, asking the crowd to forecast the unknowable future in a number of areas, including:

• When will the next prime number be found?

• Will Osama bin Laden be caught or "neutralized" by Oct. 31?

• Which city will host the 2012 Olympics?

• Will Yasser Arafat vacate Israel and the Palestinian territories by Sept. 30?

• Will the universe eventually collapse? (This market generously allows the trader to collect on the contract if evidence proves that it has begun retreating.)

Pollsters divided over markets usefulness
Pollsters interviewed by MSNBC.com were divided over the usefulness of the markets in predicting the outcome of political races.

Maurice Carroll, director of the Quinnipiac University Polling Institute, said the markets are complimentary to polls. 

“They say that they are very accurate,” he said. “And when you stop and think about it, this isn’t who I hope wins, this is a put-your-money-where-your-mouth-is look at it. So it’s an interesting forecast.”

But Eric Nielsen, senior director of media strategies for the Gallup Organization, said that the markets are of limited usefulness because trading is confined to a sophisticated group of Internet users.

“It’s just not representative,” he said. “They may get lucky and pick the election, but when we go out and do a poll, every American adult has an equal chance of being contacted. … That’s how you can say that 1,000 individuals represent the views of 280 million.”

Nielsen’s skepticism is not shared by economists at University of North Carolina, Chapel Hill, who in November 2003 produced a study of all-but-forgotten U.S. political markets that dated back to the election of George Washington as the nation’s first president.

“At times in the late 19th and early 20th centuries, betting on political outcomes at the Curb Exchange in New York (later to become the American Stock Exchange) would exceed trading in stocks and bonds,” wrote the authors, Paul W. Rhode and Koleman S. Strumpf. “… While the New York market was the center of national betting activity, similar markets emerged in Philadelphia, Chicago, Baltimore and most other major cities.”

Markets were effective prior to polls
The study showed the organized political markets, which were offered both through financial exchanges and at public gathering spots such as pool rooms, did an admirable job of forecasting election results before the advent of scientific polling in the 1930s.

In the 15 presidential elections from 1884 through 1940, the betting favorite in mid-October won 11 times (73 percent) while the underdog won only once (Woodrow Wilson in 1916), the authors found. In the remaining three contests (1884, 1888 and 1892), the odds as reflected in the political markets were essentially dead-heats.

The demise of the political markets after World War II occurred largely because of the increase in scientific polling and, as Rhode and Strumpf put it, the increasing availability of “other forms of gambling.”

That last phrase could be key if political futures markets are to re-establish themselves on the American electoral terrain.

“It’s very possible that (the markets) are illegal,” said I. Nelson Rose, a professor at the Whittier College School of Law and an expert on Internet gambling laws. “…They clearly are gambling. There are cases from the 19th century and into the 20th century when the states went after commodities trading as gambling. The reason no one gets arrested is that when Congress passes laws to regulate securities and commodities, they specifically pre-empted state anti-gambling laws … as long as the trading is conducted on one of the recognized exchanges.”

Only one of the Web sites offering political futures trading – the Iowa Electronic Markets – has received permission from the federal Commodity Futures Trading Commission to do business in the political contracts. The university project received a “no-action letter” from the commission in 1992 since its purpose is for research and education.

Web site to seek federal recognition
But Knesevitch, the Intrade.com spokesman, said his company plans to submit an application to the commission soon seeking approval to trade political futures through a recognized exchange.

“We do not make you a market, we let individuals do that, just like a stock market,” he said. “We do not take a financial position, which makes us, in our opinion, an exchange model and not a bookie model.”

But industry sources, who spoke with MSNBC.com on condition of anonymity, were skeptical that Intrade.com or other companies offering nonfinancial futures contracts would succeed in persuading federal regulators to approve of their activities.

The staff of the CFTC is currently reworking trading rules to make it clear that the Internet-based exchanges that handle trades on political races and other non-economic events are engaging in gambling rather than a form of financial-risk management, the sources said, adding that the new rules could be made public by the end of the year.

Michael Kulstad, a spokesman for the Justice Department, said he could not comment on whether the political markets are legal, saying only, “It’s illegal for Internet gambling sites to accept bets from U.S. residents.”

When push comes to shove on the legal questions, however, the online futures markets may find they have some friends in high places.

“(Tracing IP addresses,) we discovered in 1996 that the White House was one of the most frequent visitors to our site,” said Nelson of the Iowa Electronic Markets. “It might have been some intern, but at least the IP address was at the White House.”

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