Felix Salmon writes that “It’s Time for Political Event Swaps.” Why? Well, he says, “companies with political-event risk get to hedge it, while hedge funds and other investors get to invest in an asset which is completely uncorrelated with anything else.” If you’ve been keeping up with your financial econ studies, you know what a nice thing a good uncorrelated asset is.
Salmon picks ethanol giant ADM for an example:
Let’s say that you’re a company which receives enormous government subsidies — ADM, say. You’re worried that when the next president is elected, those subsidies will be slashed. So you write a swap agreement with a hedge fund, based on a nominal $100 million, say. You pay the hedge fund 7% of that $100 million per year, or $7 million. In return, the hedge fund will pay you out the full $100 million if and when your government subsidies ever fall below a certain level. The swap has a maturity date, of course, at which point both parties’ obligations cease.
Commenter dsquared says the problem with the idea is that there is “a huge moral hazard here.” Dsquared continues:
Lots of these political events are very much under the influence of the insured party (the corn subsidy is certainly something which is maintained by a large lobbying effort). Insuring this risk away, via a swap or any other means, reduces the incentive of the insured to mitigate the risk. So in this case what you’re talking about is outsourcing the corn lobby to the hedge fund industry, not obviously a sensible thing to do.
Actually not such a bad idea.
If we can just insulate ADM and other agribusiness giants from the risks of losing their subsidies, maybe they’ll stop investing so much in politicians. Sure, having taken on the risk, the hedge fund industry will be motivated to protect the subsidies. Somehow I think a parade of “family hedge fund managers” through congressional offices won’t so effectively tug the political heartstrings on Capitol Hill as the “family farmers” that the multi-billion dollar agribusiness industry routinely tosses up for the cameras.
(Another HT to Midas Oracle)