GAMBLING UNDER LAW

Our Secretary of the Treasury made an interesting admission about credit-default swaps before the House Financial Services Committee¹ which reminded me of a story I once heard about the Chicago Board of Trade:

The Illinois legislature responded first to the farmers’ general outrage and then to the more specific complaints of the Board of Trade, banning all futures contracts in 1874⁶⁸ and legislating against the bucket shops in 1887.⁶⁹ ...

In an 1879 case voiding an option contract, an Illinois appellate judge expressed the prevailing sentiment in his closing words: "Perceiving no reason why this species of gambling, though wearing the more respectable aspect of business, should be looked upon with any less disfavor by the courts than any other species, I am constrained by the facts of this case to sustain the defense."⁸⁴

These laws against gambling had to be overturned to permit modern trading at the CBT and Sec. Geithner confirms that at least some credit-default swaps are no more than gambling but they can't be reliably distinguished from swaps that have a legitimate economic purpose:

REP. DONNELLY: When the chairman gave his opening statements, one of the things he said was that we want to have innovations with value added. And we saw naked credit default swaps caused extraordinary devastation to our economy. And I know regulation is coming. Do these naked credit default swaps provide any value added, or is this simply just gambling?

SEC. GEITHNER: I know there are strong opinions on this issue, so I say this with some trepidation. My own sense is that banning naked swaps is not necessary and wouldn't help fundamentally in this case. It's too hard to distinguish what is a legitimate hedge that has some economic value from what people might just feel is a speculative bet on some future outcome. If we could find a way to separate those two types of transactions from each other, we could do that. We'd have done that a long time ago across a whole range of financial regulations. But it is terribly hard to do. But we will listen carefully to any ideas in this area, and understand why people feel so strongly about --

¹Federal News Service
March 26, 2009 Thursday
HEARING OF THE HOUSE FINANCIAL SERVICES COMMITTEE;
SUBJECT: THE NEED FOR COMPREHENSIVE REGULATORY REFORM;
WITNESS: TREASURY SECRETARY TIMOTHY GEITHNER;
CHAIRED BY: REPRESENTATIVE BARNEY FRANK (D-MA);
LOCATION: 2128 RAYBURN HOUSE OFFICE BUILDING, WASHINGTON, D.C.
SECTION: CAPITOL HILL HEARING
LENGTH: 22939 words