Frivolous, Recreational or Essential? The CFTC's Missed Opportunity
How a sharper focus on economic purpose could have reshaped event contract regulation--and set a lasting precedent
Last week, we continued our coverage of the Kalshi v. CFTC case. We explained how The Court of Appeals for the D.C. Circuit saw through the ambiguity but the CFTC missed its moment.
This begs the question: Why?
Not all that long ago, the CFTC had already argued along similar lines of what the Court of Appeals was suggesting: gaming means gambling and economic purpose matters. When rejecting Nadex’s political event contracts in 2012, the CFTC was firm and did not mince words:
WHEREAS, the legislative history of CEA Section 5c(c)(5)(C) indicates Congress's intent to restore, for the purposes of that provision, the economic purpose test that was used by the Commission to determine whether a contract was contrary to the public interest pursuant to CEA Section 5(g) prior to its deletion by the Commodity Futures Modernization Act of 2000;
The language softened a bit in the 2023 Kalshi order. We observed:
“Congress's Intent to restore” became “Congressional intent for the Commission to consider, among other things…” The economic purpose test turned into “a form of the ‘economic purpose test’, with the word form softening the stance and the economic purpose test being wrapped into quotation marks. In hindsight, perhaps these were signs that the Commission was not completely comfortable with the idea of using the economic purpose test. Still, the order dedicated about four pages to hedging and price basing and used those arguments before it presented the integrity arguments.
The special rule has not changed since 2012. The Kalshi contracts aside, the CFTC has not exercised its authority to commence a 90-day review ever since. There was the ErisX saga in 2020-21, but ErisX, perhaps seeing the writing on the wall, withdrew its sports betting futures contracts before the Commission could rule on it.
What could be the rationale behind the CFTC’s change of heart, especially when arguing it as they did with previous cases was likely the best path to a victory?
The answer is not entirely clear. Is it incompetence? A shift in leadership and views? A skeptical mind might jump to those conclusions–especially one inclined to distrust the government–but we reject that line of thinking. It’s too easy, too judgmental. We owe it to ourselves to dig deeper, to uncover a more compelling explanation. As we do, let's not lose sight of the fundamental force that shapes most human behavior: Incentives.
As an economist, I learned long ago that everything boils down to incentives. Back when I was a teacher–many moons ago–I taught from Greg Mankiw’s Principles of Economics. Among its core lessons, the fourth principle stood out as particularly powerful: “People respond to incentives.”
The motive is so powerful that author Steven Landsburg, in The Armchair Economist: Economics and Everyday Life, went even further and said:
Most of economics can be summarized in four words: “People respond to incentives.” The rest is commentary.
Our inquiry centers on understanding what drives the CFTC’s behavior. To do that, we must carefully examine their incentives. If we look close enough there are some important hints hiding in plain sight.