Hollywood Stock Exchange is a stacked deck in a casino royale

By Steven Pearlstein
Friday, March 12, 2010

Investors learned this week of Wall Street's latest attraction -- a new "futures" market where anyone from casual moviegoers to Hollywood moguls would be able to wager on the success of upcoming movies.

In many ways, the Hollywood Stock Exchange is simply the logical extension of the recent trend in financial markets, which have long since outgrown their original purpose -- to raise capital for real businesses -- and have now turned themselves into high-tech casinos offering endless opportunity for speculation.

The rationale for this market in movie futures is roughly the same as the one offered for stock and commodities futures, or credit-default swaps or even the market in "synthetic" CDOs, those securities designed to mimic the performance of the real-life packages of mortgages and other debt instruments. Apologists talk about how much "liquidity" they bring to these markets, magically lowering costs and moderating price swings while allowing all manner of businesses to hedge their risks. And because these markets can accomplish these things with absolutely no unpleasant side effects, it is folly to even consider regulating them and stifling this wealth-producing innovation.

To understand what hogwash this all is, take a closer look at the Hollywood Stock Exchange, which the New York Times reported will soon be launched by Cantor Fitzgerald.

As with all futures markets, the defense of this one starts with the argument that it's perfectly benign to allow betting on a movie's box-office performance because it won't have any impact on actual ticket sales -- just as betting in the stands won't affect the outcome of the match on the field. But, of course, that argument breaks down when it turns out that the bettors in the stands are the players on the field, which is exactly what the Hollywood Stock Exchange envisions.

If nothing else, the movie exchange is an obvious invitation to trading with insider information, allowing those who are actually producing a movie to bet on its outcome against outsiders who have never read the script, reviewed the dailies or seen the marketing budget. And surely it won't be long before theater owners and moviegoers begin checking prices on the exchange before deciding which films to show and attend, thereby altering the very outcomes that the exchange is meant to forecast.

And because there is no limit on the amount you can bet on any movie, there is the real possibility that a film that cost only $100 million to produce could cause financial losses many times that amount, creating a contagion effect that could dry up funding for the entire industry.

Such concerns are hardly fanciful. In fact, they are analogous to what happened in recent years as a result of abusive and unregulated trading on futures and derivatives markets.

Does anyone really believe, for example, that Goldman Sachs or J.P. Morgan Chase would not have been more careful with those crappy mortgage securities if they didn't know they could hedge their exposure with credit-default swaps?

Have we already forgotten that, thanks to synthetic CDOs, defaults of several hundred billion dollars in subprime mortgages could generate a trillion dollars in losses to the financial system?

And if it is illegal to short a stock you neither own nor control, why allow "naked" short-selling of bonds, credit-default swaps or an ounce of copper?

The truth is that no great economic or social purpose is served by allowing people to profit from assets they do not control or hedge risks they do not have.

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