• How to make a profit in politics

    IEM / msnbc.com

    The red line in this chart shows the dramatic rise in the price of Newt Gingrich shares on the Iowa Electronic Markets' exchange for the 2012 Iowa GOP presidential caucus. "ROF" is "rest of field."

    By Alan Boyle, Science Editor, NBC News

    How many stockbrokers can boast about a trade that brought in more than 200 times their investment over the past six weeks? Political pundits could, if they had the foresight to "invest" in GOP presidential hopeful Newt Gingrich's prospects back in October.

    The Iowa Electronic Markets make it possible to do such a deal: The IEM operation, sponsored by the University of Iowa's Tippie School of Business as a economic research project, is the only market in the country that has the tacit blessing of the Commodity Futures Trading Commission to let traders lay real money down on political predictions. In other contexts, this might be known as a "bet."

    Here's how it works: You can buy up to $500 worth of shares in a political proposition — for example, the proposition that Gingrich will finish either No. 1 or No. 2 in January's Iowa GOP presidential caucus. If the proposition pays off, you'll be paid $1 for each share. If it doesn't, the shares are worthless. Thus, the share price on a given day should reflect the traders' assessment that the prediction will come true.

    Researchers have reviewed the IEM's record since the Bush-Dukakis faceoff of 1988 and report that political prediction markets are at least as accurate as traditional political polling. During the 2008 presidential campaign, traders leaned toward a Democratic win more than a year before the actual election. Not much changed in the market after that year's party conventions.

    Gingrich, however, has experienced a huge shift in fortunes over the past six weeks, on the political circuit and on the IEM: His Iowa caucus shares were trading at just 0.3 cents on Oct. 13, but on Tuesday they reached 69.1 cents. (Ron Paul has just edged ahead of Mitt Romney as the runner-up.)

    "Gingrich is soaring," University of Iowa spokesman Tom Snee told me today. "He's actually gone up from yesterday. Today he's at 75 cents a share."

    That means every dollar invested in Gingrich in mid-October would yield $250 today.

    Now, before your head starts swimming at the prospect of making tens of thousands of dollars in the political game, here's a reality check: There's a limit to how much you can invest in an IEM proposition, and it's not just the $500 account limit.

    "You can only buy something if it's available for sale, and we're not going to have 166,000 shares for sale," Snee said. Right now, there's only about $5,000 total invested in the Iowa caucus market. The entire value of investments in all of the IEM's markets is about $185,000, held by about 1,200 traders. You couldn't possibly have spent the whole $500 buying up Gingrich shares at 0.3 cents per share.

    Here's how Iowa professor Joyce Berg, director of the IEM, explained the issue in an email passed along by Snee:

    "All IEM contracts in the RCONV [Republican Convention] market are issued by selling bundles (one of each contract in the market) for $1.  Because exactly one of the contracts will pay off, the IEM has exchanged $1 for something that will be worth $1.  In your example, for a trader to spend $500 on contracts selling at $0.003, there would need to be $500/.003 = 166,667 Gingrich contracts available.  The only way that could happen is if other traders had spent $166,667 purchasing bundles. The funds to trade the hypothetical trader’s gains come from other traders.  That is, for every gain, there is an equal loss in the market.

    "In other markets where traders can sell short, there are banks that guarantee the trades.  In the IEM, we don’t have that issue due to the way we use bundles to create contacts."

    So if you were hoping to use your political acumen to pay for a condo, the IEM can't help you. But there are some potential bargains out there. Heck, just a couple of weeks ago, Herman Cain's Iowa caucus shares were trading at more than 25 cents each. Now they're worth a penny. If you have a hunch that Cain can revive his fortunes, there's money to be made. How's that for an economic plan?

    More about prediction markets:

    To handicap the political marketplace, check out NBC Politics on msnbc.com. And to find out what's going on in the financial markets, check in with msnbc.com's Business section.

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