A Futures Market for Terror

Walk with me down a pathway leading into the fascinating future of tomorrow’s weapons systems. Imagine, if you will, a cockroach-size robot that can transmit high fidelity color and audio images, and – like the cockroach it mimics – can maneuver over and around rocks, up and down stairs, and in and out of small areas.

Consider  a honeybee swarm that searches out explosives instead of sweet nectar.

Or a remote MRI-like device that can identify from a queue of people waiting to board a plane the one person who intends to hijack it.

These current projects under sponsorship of the Defense Advanced Research Projects Agency (DARPA) are just a small example of the outside-the-box thinking by these creative experts.

But there’s more: DARPA is trying to teach a rat to get water just by thinking about it. DARPA contracted scientists are developing artificial organs and prostheses that could greatly increase human performance – something like the Six Million Dollar Man. They’re also working on pills that could enable humans to go days without food, sleep or water. And my favorite: DARPA fully expects to develop an electronic substitute for the hippocampus, that part of the human brain that controls memories and complex instructions, so that we might eventually be able to download memories or complex instructions from one individual, and then upload them to another person, or even to enable direct communication from brain to brain.

This is fascinating stuff – and the potential for making our fighting men invincible is as real as tomorrow’s headlines.

One of DARPA’s most recent projects that resulted from the same kind of outside-the-box thinking sparked an news media stampede last week that said more about our media and political culture than it did about the scientists.

For some time, economists have understood that futures markets are very efficient predictors of human behavior, and even of future trends and events. For example, a futures market set up to predict the outcome of an election is significantly more accurate in the long term than opinion polls, and even in the short term, futures markets outperform exit polls. The futures price for oil is widely used by both political and economic analysts in their forecasts precisely because it is arguably the best predictor available for this critical commodity.

The predictive accuracy exhibited by futures markets has many underlying reasons, and in all probability is not very well understood. Nevertheless, their accuracy is undeniable, and this despite people’s attempts to manipulate the market in order to take advantage of this accuracy.

This predictive accuracy of the futures markets did not escape DARPA’s managers. DARPA set up a research project in an attempt to exploit this accuracy in the ongoing fight against terrorism. The idea was to use established securities such as indexes of political, economic and military activity to create a futures market. Probably the most useful such market would have been for futures in a weighted average of various political indicators – a “political instability index.” This index would have consisted of the number of mass demonstrations, unemployment levels, arrest, and even assassination attempts.

The only way a futures market can work properly is for the market to be freely available to anyone who wishes to participate. A futures market is a zero-sum market, meaning that every gain is exactly matched by a corresponding loss. There is no actual net gain or loss: someone always receives what someone else gives up.

In the typical commodities futures market two players predominate. The primary group consists of those who have a vested stake in the outcome, process, product, or whatever the market is created for. These players normally use the futures market as a hedge against future losses or to guarantee future gains, very much like an insurance policy where a future loss is covered or a future gain is guaranteed, less the cost of the “insurance.” The second group consists of speculators, players who “gamble” on the eventual outcome. In effect, speculators provide the “insurance payout” for the first group. A commodities futures market can only provide a real-world hedge against real-world gains or losses if both these groups participate. Each investor must have a speculator on the other side of every deal or the system won’t work.

When a futures market is for non-commodities, a hedging factor may still play an important role, such as in market-index futures, where a player can hedge against a loss or guarantee a profit by participating in this market. On the other hand, when the market trades non-material things such as a political instability index, there is nothing to hedge against, and the only players in the game are speculators – gamblers playing against each other.

DARPA proposed the Policy Analysis Market as a futures market serving only speculators. It limited transactions to $100 to make it possible for widespread participation while eliminating any possibility for windfall profits and the concurrent temptation to manipulate the market.

DARPA set up the preliminary market system to allow traders to propose securities in various events. Somebody on the Policy Analysis Market Website speculated that some traders might actually propose assassination securities. This speculation was part of a larger conversation that served to develop the outline of the actual market strategy that DARPA would eventually put in place. Assassination futures never were part of the official futures market under consideration.

Writing in the New York Times on July 31, 2003 (“A Good Idea with Bad Press,” reporter Hal Varian noted,  “That off-the-cuff speculative remark had fatal consequences, alas.”

With few exceptions (notably an article by David Ignatius in The Washington Post, “Back In The Safe Zone,” and the already-mentioned New York Times article), the news media vilified DARPA and project supervisor retired Rear Adm. John M. Poindexter, who presided over the plan’s development by social scientists at Caltech. Editorials screamed about gambling on assassinations, left-wing apologists opined on terrorist manipulation of such a market for profit (even though trades were limited to $100, not exactly windfall profits for Osama bin Laden), Poindexter’s activities during the Reagan administration’s Iran-Contra scandal were dusted off and rehashed in light of his alleged current nefarious activities. The feeding frenzy mushroomed overnight into a full-blown media orgy.

Democrat congressmen and senators quickly stepped to the plate, decrying the folly of a futures market in terrorism, denouncing Poindexter and the Bush administration for their inability to exercise sound judgment. Seeing the public outcry, even prominent Republicans like Sen. John Warner, R-VA, jumped on the bandwagon.

Throughout Washington’s hallowed halls and across the nation the ground trembled as the sky fell. Bouncing acorns not withstanding, the White House withdrew its support for the futures project, and Poindexter resigned. What may well have been one of the most imaginative and potentially productive tools in our arsenal of anti-terrorism weapons, succumbed ignominiously before the relentless media onslaught and the hysterical tantrums of Senators Hillary Clinton and Barbara Boxer and their gutless colleagues from both sides of the aisle.

Varian laid the failure of this program at the foot of “poor public relations” on behalf of DARPA. He wrote in his New York Times article that “We desperately need better ways to forecast political instability, and the Policy Analysis Market had significant promise.” He concluded that “It's sad to see poor public relations torpedo a potentially important tool for intelligence analysis.”

While I agree on the importance of the Policy Analysis Market, I think the failure actually resulted from the ignorance and political bias of the initial media reports, and the resultant political brouhaha. I applaud the courage of journalists Varian and Ignatius for going against the flow, and more so in that their articles appeared in the very publications that spearheaded the feeding frenzy.

I wouldn’t be surprised, however, to see the Policy Analysis Market resurface in another guise. It’s an idea whose time has come, and not even the Post nor the Times can stop the march of history.