Posted on 07/30/2003 6:39:05 PM PDT by No Left Turn
Terror Futures – Expiration of a Great Idea
Terror futures expired Tuesday – before they got a chance to trade. That’s a shame. Pricing action of such a derivative could provide an early indicator that deadly information had surfaced in the market. And terror futures could be a means of providing insurance to small business and individuals who are exposed to the real financial risk of terrorism, but have few ways of protecting against it.
Based on the details made public by the Department of Defense, the market would have allowed traders to take either side of a bet on pre-set scenarios, such as the assassination of a certain Mideast leader, or another terrorist attack on the U.S. The latter scenario was the focus of intense criticism from Democrats, which led to a quick retraction of the idea by the Department of Defense.
In striking similarity not often seen outside those working from the same talking points memo, Democratic Senators Ron Wyden and Byron Dorgan both likened the idea to a “betting parlor,” with Wyden also calling the concept “grotesque.” Senator Dorgan further inveighed, "Can you imagine if another country set up a betting parlor so that people could go in ... and bet on the assassination of an American political figure or the overthrow of this institution or that institution? But these “betting parlors” already exist; we call them the New York Stock Exchange, the currency markets, the New York Mercantile Exchange, the Chicago Board of Trade, or any other marketplace you can think of.
In fact, if you hark back to the days immediately following the September 11 attacks, many people thought that prior to the attack, the terrorists had used the stock exchanges as books for their short positions – a wager that prices will head lower – in insurance and airline stocks. The evidence cited to support this theory was the fact that those stocks had moved lower prior to the event, providing circumstantial evidence that someone, maybe even Al Qaeda or its sympathizers, knew what was going to happen and wanted to profit from it.
While there’s no solid proof for this theory, the logic behind it is sound. Markets serve to aggregate information, allowing factors known only to a few to affect price before they are known to a wider audience. For a practical example, the next time your local news outlet tells you that a tropical storm is in the Gulf of Mexico, check the price of oil futures and you’ll likely see that they rose in the days before you heard the report. That’s because people that have a vested interest in oil prices pay closer attention to potential events like a Gulf Coast storm than you do. By the time you find out about Tropical Storm Leo from Al Roker, the oil trader has likely known the information for three days and has already adjusted his oil position accordingly.
So why not just focus on existing markets to determine terror risk? Those markets are affected by several other factors, such as earnings, economic trends and management competence, meaning sharp price movements can be explained away by reasons other than terrorism.
By contrast, the smart money in markets based solely on political risk will likely be those who have expertise in the area and those who will seek, process and discount only information dealing with political and security matters. One could imagine think tanks throwing money in such a market, seeing financial advantage in their expectations and knowledge of the events their betting on.
Government watchers could react to the affect this information flow has on the market, alerting field agents to look into market rumors, check with informants and sources and scour intercepted communications to determine whether there’s anything to a burgeoning market trend or a sudden spike in prices.
Aside from their predictive value, terror futures would also fill a void created by a lack of terrorism insurance for individuals and all but the largest corporations.
Consider the value of terror futures to, say, a small event planning company producing a fourth of July function in Washington, D.C. If an attack occurred around that time forcing the cancellation of the event, the company could be ruined. If it had access to a product that was sure to gain value as a result of a terrorist act, the company could buy financial protection.
A similar concept is already at work in the weather derivatives market, where weather futures or options can be purchased to protect businesses against detrimental shifts in temperature. In this market, a ski lodge or a snow mobile maker can buy weather futures to hedge against warm winter temperatures. If a winter is warmer than usual, the weather derivatives gain value, offsetting the economic damage caused by a lack a snowfall.
As for individual Americans, it’s easy to see a person who purchased a rental property in Hoboken, NJ, buying terror futures to cushion the blow should another attack happen in New York and drive prospective tenants off the banks of the Hudson.
The charge that terror futures are immoral or grotesque is silly. Consider the oil trader mentioned above. His purchase of oil futures ahead of a Gulf Coast storm that could shut refinery capacity is a completely rational and prudent act. That some poor Louisianan may be killed by the storm is irrelevant; it enters the trader’s mind only in the sense that storms cause all kinds of destruction, human and commercial, and it’s best to hedge against such potential. The same can easily be said of terrorism.
The Pentagon may have sidestepped much of the current criticism had it highlighted the risk management potential of their idea. Instead of calling them terror futures, they could have been presented as political risk futures. The intelligence value could have remained a quiet byproduct of the venture.
So why not just focus on existing markets to determine terror risk? Those markets are affected by several other factors, such as earnings, economic trends and management competence, meaning sharp price movements can be explained away by reasons other than terrorism.
For the amount of time and money that the Pentagon would have spent to run this thing (which would have been much easier for terrorists and other anti-U.S. parties to manipulate than the real financial markets), they could much more cheaply hire professionals and fund the technology needed to factor out these things. Or they could just buy info from the various insurance firms which are already selling political risk insurance policies.
Really? Are these exchange traded? I'm thinking that if "political risk" futures are a good idea, then some innovative futures exchange, such as the one with weather futures, should be able to come up with these themselves.
No political points were scored, but the political jerk offs got to play the indignant uncle for a day or two.
They were going to limit it to small amounts invested to prevent that sort of thing.
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