Robin Hanson reports on a popular article based on a paper by law and economics professors Eric Posner and Glen Weyl in which they advocate a kind of Food and Drug Administration for financial instruments. The paper is titled “An FDA for Financial Innovation: Applying the Insurable Interest Doctrine to 21st Century Financial Markets.” Here’s part of the abstract:

We propose that when firms invent new financial products, they be forbidden to sell them until they receive approval from a government agency designed along the lines of the FDA, which screens pharmaceutical innovations. The agency would approve financial products if they satisfy a test for social utility that focuses on whether the product will likely be used more often for hedging than for speculation.

I guess that’s because, you know, the FDA has worked out so well.

But to the point. They get that being able to hedge is valuable. But they think that speculation is not. Why? They write:

By contrast, when a person speculates, that person exposes herself to increased net risk without offsetting a risk faced by a counterparty: she merely gambles in hopes of gaining at the expense of her counterparty or her counterparty’s regulator. Speculation is a zero-sum activity, which, in the aggregate, harms the people who engage in it, and which can also produce negative third-party effects by increasing systemic risk in the economy.

They continue:

When two people bet over whether a coin will turn up heads, they each incur the risk that they will be poorer in the future, when, assuming that they are risk-averse, the gain will not be sufficient to outweigh the loss in terms of utility. Thus, rational people will not engage in speculation in the first place unless (1) they like to gamble (in which case there are cheaper ways, like casinos, to satisfy this preference), (2) at least one party is confused (which we believe is extremely common), or (3) they are engaging in regulatory arbitrage (which is also extremely common). Thus, there is no social gain from permitting speculation.


I don’t know if they back up their claim that casinos are a cheaper way to gamble. That doesn’t seem obvious to me at all. But if we take their argument seriously, they should want to ban gambling also. After all, gambling is zero-sum. Actually, it’s worse: when you take account of the costs of gambling–setting up a casino, etc.–it’s negative-sum.

In a separate article, they do write:

Our skepticism about speculation shouldn’t imply that we oppose all forms of gambling. In controlled and appropriate contexts, it can be a source of entertainment for people who are aware of and willing to accept the potential losses. But participants in financial markets are usually seeking financial security rather than entertainment, and they typically have little sense of the risks they are taking on.

In other words, those who gamble in financial markets are less informed, according to Posner and Weyl, than those who gamble in those really-cheap casinos. I didn’t see them give any backing for this claim.

Let’s take it further. Take tennis. Tennis is zero-sum also. When one player wins, one player necessarily loses. Moreover, there’s the cost of the tennis court. Also, tennis is time-intensive. It’s probably worse than many forms of gambling that take just pushing a few buttons. So if we take Posner’s and Weyl’s argument seriously, there’s no good reason not to ban tennis.

Have I left something out? I have. It’s the pleasure of playing tennis. I think rational people do play tennis and one reason is that they enjoy it.

Similarly, many rational people gamble and enjoy it. On a flight from Las Vegas to San Jose in 2001, I noticed that the crowd on the plane seemed particularly mellow. I was alone and so I started to listen to conversations and heard lines like the following: “I found this game in x casino that was a really fun way to lose $40 slowly.” That’s when I came up with the line (I’m not saying it’s original with me but I did come up with it on my own) that Las Vegas is Disneyland for adults. When I was a graduate student at UCLA, many of my professors bet on particular stocks. I recall the late Earl Thompson calling me late one night because he had heard that I was betting on Piper Cub and he wanted to know what I knew. Maybe these professors were more ignorant of the risks than gamblers in Vegas–I don’t know–but they enjoyed the game. By the way, sitting in their offices in Bunche Hall and calling a broker–even in those days–was cheaper than flying to Vegas.

So the same argument that can be used for allowing tennis can be used for allowing gambling and can, in turn, be used for allowing speculation. Moreover, there’s an even stronger case for allowing speculation: speculation produces a public good, the good of price discovery.

By the way, Robin Hanson performs an excellent reductio ad absurdum in his post, pointing out that the same argument Posner and Weyl use in their popular piece would lead to the conclusion that the government should ban conversations about elections.