Coleman vs. Franken: Investing in the future

Sen. Norm Coleman and Al Franken
Nicholas Roberts/REUTERS/Eric Miller
Bought and sold: Sen. Norm Coleman and Al Franken

Ian Hoffman, like just about any American not living under a rock, recalls the 2000 presidential election with bemusement that lingers to this day. The difference is that Hoffman, a 39-year-old attorney with the Department of Justice in Cleveland, took a bit of a bath on Bush vs. Gore.

Hoffman had bought investment “contracts” in what’s called the Iowa Electronic Markets, the brainchild of a trio of economics professors at the University of Iowa who hatched the idea during the 1988 presidential campaign. The idea of IEM was to see if a futures market could be used as a predictor tool in political races, and not just in areas of finance and commerce.

By 2000, IEM was drawing in the neighborhood of 1,000 investors every four years for each presidential campaign, and Hoffman was one of them. Hoffman had put some money in a market involving the former VP and the son of prez 41. Whoever would win the popular vote would be the “winner” in that market, and that’s where Hoffman ran into trouble, of course. Remember who won the popular vote? (Hint: It’s not the guy we currently call president.)

“I hedged my bet,” Hoffman says now. “I had a feeling Bush would win. Not that I wanted him to, but I thought he might win.”

So, staying true to the old gambler’s axiom that you should bet with your head and not your heart, Hoffman ponied up for W. “I thought if Gore wins, it’s good for the country, but if Bush wins, then I get a little money,” Hoffman says. “Then Gore starts running up the popular vote in California, and I lost on both accounts.”

In all, Hoffman was set to win as much as $700, but instead won $200, on Campaign 2000.

“My greatest failure,” Hoffman says, noting all the IEM markets he’s invested in since 1992.

That wackiness was in fact a rare moment in the Iowa political futures market, where, its progenitors, advocates and participants say, the true indication of which candidate will win the presidency can be found. Forget polls—futures are where it’s at. According to University of Iowa Tippie College of Business professors associated with IEM, their markets have been more accurate than 74 percent of some 1,000 polls in all the presidential campaigns since 1988. And while polls are on average within 1 3/4 percentage points on final popular vote, the Iowa markets are usually within 1 ¼ percentage points.

In short, if you want to know who’s going to be president, look at the markets, not at the polls. And this week, in partnership with MinnPost.com, IEM is launching a new market this political season: You can put money in the Senate race between Sen. Norm Coleman, R-Minn., and Democrat Al Franken. MinnPost will report on its site how the market is doing. To invest in the market, go here.

“Markets are different than polls in that they don’t ask how you would vote,” says Iowa professor of economics Forrest Nelson, one of the three who came up with the idea. “But they ask how you think everyone will vote come November.”

The surprise of ’88 leads to an idea
Where did the idea for the market come from? An African-American candidate was running for the Democratic nomination, though every poll considered him a long shot. Then one day, he staged a surprise win in a Midwestern state. Sound familiar? It was, in fact, not Barack Obama in Iowa earlier this year, but Jesse Jackson in Michigan 20 years before.

“It was a conversation we had at lunch the next day,” Nelson recalls, referring to two of his econ colleagues at the time, George Neumann and Robert Forsythe. “We were chatting about what the polls were saying [going into Michigan] and said that if the futures markets in Chicago predicted like polls, those markets wouldn’t exist.”

So, the novel idea was born: Why not apply the same apparatus to presidential elections? And what started out as a “research question,” according to Nelson, soon turned into a real futures market that accurately predicted the outcome of the Bush/Dukakis race in 1988.

Here’s how it works. The IEM sets up two markets for the races: A “winner-take-all” market and a “vote-share” market. IEM (originally called the Iowa Political Stock Market) came up with an agreement with the federal Commodity Futures Trading Commission that limited investment “contracts” to $1 and any investor’s total to $500.

In the “winner-take-all” market back in 1988, if you had contract on Bush, you won a $1 on whatever you paid for. If you had a contract on Dukakis, you got zilch. 

The “vote-share” market is slightly more elaborate, where investors are picking up contracts on the likely total popular vote. In 1988, for example, Bush received 53 percent of the popular vote. If you were astute enough to pick up a Bush contract when he was polling around 40 percent, and he was trading, say, at $.45, you would have picked up eight cents on that investment.

Investor trading, like the stock market or any other futures market, sets the price of the contracts. In the current race, Obama is generally trading just a shade above 60 cents in the winner-take-all, which means it might not be a bad time to invest in some McCain contracts at 39 cents. In the vote-share market, it’s a virtually dead heat—spend your money whichever way. To see current trading prices, go here.

Why open a market on Coleman/Franken
Small stakes, to be sure, but the markets proved to be popular among traders, economists and political geeks, drawing some 200 investors in the pre-World Wide Web era of the Internet in 1988. This link to the IEM’s web site here offers an FAQ and instruction on how to open an account.

While IEM has focused mostly on presidential races, it has dabbled in congressional races in the past, and opened its market on Coleman/Franken this afternoon.

Joyce Berg, an accounting prof at U of I and the director of IEM, explains why: “There’s interest in Franken/Coleman for a couple of reasons. First, the markets work best when there’s an incumbent running against another person. What we look for in markets is people paying attention, and here you have a contested race that also features a celebrity.”

The race will have two markets: the winner-take all and a vote-share market. There will be three-contracts in each, one on the Republican candidate, one on the Democratic candidate and one on — Dean Barkley and the other Independence candidates might be chagrined to know — “Rest of Field.”

“It’s a pretty high-profile race with two high profile candidates,” says Tom Snee, a communications spokesman for the University of Iowa and a Minnesota native. “If it was Coleman/Ciresi we probably wouldn’t do this.”

The main thing for investors, Berg and Snee note, is that they seek “information aggregation” before laying down any money. In other words, nobody’s going to take the bait on a race no one knows about. They both believe the Minnesota market will draw.

“To us, a success means a market that’s an accurate predictor,” Berg says, adding that the Coleman/Franken payout will be based on results from the Secretary of State’s office. “We need more people and Minnesota people in the market.”

It’s pointed out to Berg that Barkley, a former U.S. senator, is in the race. “We may spin him off in his own contract,” she says.

Why does it work?
Nelson says the initial success in 1988 caught him and his colleagues a little bit by surprise, but not by much. “Any economist worth his salt puts belief in markets,” he says.

It’s worth remembering how polls function: By taking the temperature of which candidate individuals might prefer. Markets don’t deal with such sentimentality — and, of course, there’s money involved.

Why does IEM do so well? “The answer is there’s a lot of parts,” Nelson says. “People have an incentive to get it right, it gives them an incentive to make money. Also, polls don’t predict how a race will actually turn out. We think it’s important to put money on the table, but how much tends not to matter.”

But, as this Scientific American story on IEM and other futures markets point out, there is hardly consensus—surprise–among economists on the value of such markets. One argument, in a nutshell, says that comparing markets to polls is apples to oranges, and not a good indicator of a market’s success as a predictor.

But, Nelson says, that may not mean much to the investors. “We’ve had people from Wall Street, who do this every day for high stakes, do our markets at the end of the day,” he says. “It’s like a busman’s holiday for them.”

Ian Hoffman, the Cleveland attorney, puts himself in another category that participates, that of political junkie. He’s an Obama man, he says, but he’s eyeing up the cheap price of the McCain vote-share contracts.

“Then if it comes up to 50 I’ll sell it and then figure out what to do,” Hoffman says.

At the end of the day, it’s a little bit about the money, Hoffman says, but also something else. “There’s a psychic upside,” he says. “It’s sort of the idea that you feel a little smarter than anyone else. And you have a chance to prove it too.”

Comments (1)

  1. Anonymous Submitted by Anonymous on 08/23/2008 - 02:07 pm.

    http://www.washingtontimes.com/news/2008/aug/23/franken-closes-gap-in-race-for-senate/

    Franken closes gap in race for Senate

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