Let's Face Reality, and Deregulate Sin

In the mid 1990's I worked as a speechwriter for the president of Kraft Foods, which was then a subsidiary of Philip Morris. We foodies shared a glamorous office building in Westchester with our tobacco cousins, where a greeting sign read something like, "We welcome both smokers and non-smokers." On our side, the air was fresh; on theirs, a heavy shroud of smoke blanketed corridors and cubicles.

Over a decade later, last month a watershed piece of legislation passed the senate and the signature of President Obama (himself still smoker-in-chief). The new law gives the Food and Drug Administration agency authority to set standards for nicotine and other chemicals in cigarettes, and bans most flavorings (not menthol) used to enhance taste. It tightens marketing and advertising rules drastically, eliminates terminology like "light" or "mild", and imposes more dominant and graphic warnings on cigarette packages.

The new law has not markedly affected tobacco stocks, and may have actually removed some overhanging uncertainty. "It makes it easier for the industry to have just one regulator," says John Dunham, who was senior U.S. economist with Philip Morris from 1995 to 2001. "So far, we've had a hodge podge of rules," explains Dunham, now president of New York consultancy Guerilla Economics. The Federal Trade Commission was overseeing advertising; the Department of Agriculture was regulating tobacco; and different state authorities determined marketing and packaging. For example, in some states, 16 year- olds can buy cigarettes, while in others the legal age is 21.

Dunham is wary that the FDA's culture may prove overly "anti-industry", whereas another agency, such as the Department of Agriculture could be a more neutral arbiter. Charles Norton, portfolio manager at the USA Mutual Vice Fund, also dislikes the legislation. He muses, should the FDA, whose mandate is a focus on the health and safety of the public, be in charge of a toxic and addictive product? In any case, the agency is already stretched thin, dealing with pharmaceutical issues. "This legislation does not recognize that combustible products are relatively more dangerous than smokeless ones. Scientific experts differentiate among products, along a continuum of risk," according to Norton.

As for ratcheting up the warning messages on packages, Norton notes that adding more dire labels has had little impact or correlation with business in other markets, including Australia, Mexico, Brazil, India and Switzerland.

Aces High

In early June, gamblers' checks began to bounce. American federal prosecutors had ordered four banks, including Citibank and Wells Fargo, to freeze $34 million in the accounts of online poker players, citing the 2006 Unlawful Internet Gambling Enforcement Act , which prohibits banks and credit card companies from receiving money for online betting. Yet UIGEA never clearly defines what is illegal. The story dates back to 1962, when Congress passed the Wire Act to prevent horserace bookies from using the telephone to place bets across state lines - but of course back then no one contemplated the internet.

In 2001, Michael Oxley (of Sarbanes-Oxley fame) came up with a new approach to control internet gambling. Over a golf game, he explained it to Frank Fahrenkopf, president and CEO of the American Gaming Association. It was not illegal to place the bets, and the websites were all offshore. Oxley pondered, how could lawmakers influence behavior? Since 90% of gambling debts were settled by credit cards, they could make that debt unrecoverable and put the burden on the card companies and processing banks. "Although they have until December 2009 to implement UIGEA, banks are running scared," says Fahrenkopf. "They have no way to know if accounts are being used for internet gambling."

Enter Rep. Barney Frank, who has introduced a bill, scheduled for September, to thwart UIEGA and legalize internet gambling. Disparate interests are lining up on both sides: the bricks and mortar casino industry, who know where their bread is buttered, oppose it. Harrahs, which own the World Series of Poker, supports the bill.

President Obama, himself a poker player, should have some sympathy for the online players. As a young state politician in Illinois, he was known for his stone face at weekly poker games, where he learned to fold fast when he did not think he could win.

Strange Bedfellows

Government, especially at the state level, is the main beneficiary of cigarette sales and tax revenues. "Since it is the major player, making the most profits, if you are a cigarette producer, you are manufacturing for the government right now," says Dunham. The new rules will allow the government to commoditize the product, by controlling packaging, marketing and branding. In theory, economics suggest that the government should maximize its revenue through the lowest cost producer - right now probably Altria, owner of Philip Morris. If society tolerated it, the government could make even more money by making generic cigarettes, and selling them in government stores!

In a regulated environment, the largest company will experience both advantages and drawbacks. It may have a larger base of sales to spread the costs of regulation out, as well as superior R&D to direct toward addressing new rules. At the same time, a company like Philips Morris has invested vast sums in its brand and Marlboro cowboys. Dunham points out, "that could be worthless at the wave of a regulatory wand."

Unlikely coalitions have also emerged around gambling. In the Republican party, far right wing religious conservatives believe that gambling is a sin that may condemn constituents' souls to hell. They have oddly joined forces with some Democrats, who do not think people are smart enough to make appropriate judgments about their own money, and believe government should be paternalistic.

In the end, legalized gambling, like tobacco, represents a hefty source of revenue for the treasury. Meanwhile, copious taxes flow overseas to the countries that permit online gaming. When Congress tried to outlaw alcohol in 1919, prohibition only drove bootleg drinking underground. Why not face reality and legalize gaming, which is here to stay, along with proverbial cakes and ale.