Philadelphia Inquirer July 31, 2003, Thursday SECTION: BUSINESS AND FINANCIAL NEWS KR-ACC-NO: K0178 LENGTH: 698 words HEADLINE: Nothing good would have come out of terrorism futures BYLINE: By Jeff Brown BODY: Imagine you could make money if a suicide bomber struck in the Middle East. You could _ if you bet someone that there would be an attack, and there was one. But would you do it? For most of us, the idea is appalling. A lot of congressmen think so, too. When the Pentagon disclosed Monday that it was setting up a futures-trading market for speculators to bet on the likelihood of terrorist acts, the outrage was so quick and intense the plan was scuttled the next day. But did the scheme have more going for it than critics thought? Critics argued terrorists could use the market to profit from their own acts. But as planned, this market probably would have been too small to offer substantial winnings. In fact, terrorists could make far more by manipulating existing markets _ using short sales to bet that a company's stock would fall, then killing its chief executive, for instance. Critics' main objection was that making money on terrorism would be distasteful, grotesque and immoral. But ordinary investors already use the financial markets to make money when bad things happen. War boosts shares of defense contractors. Pharmaceutical companies make profits on disease. Oil stocks jump when there's trouble in the Middle East. Construction companies, their investors and employees will make money rebuilding Ground Zero. None of these is immoral because these firms are solving problems, making the world better. As planned, the terrorism futures scheme would have been used to predict _ and thwart _ acts of terrorism, the Pentagon said. With lives saved, questions of taste and morality would have melted away. But could futures trading really predict terrorism? Typical futures markets are used for speculating on future prices of commodities such as wheat and oil. Futures contracts are used to lock in a commodity's price months down the road. These enormous markets are a proven tool for revealing the consensus about where prices are headed. They work quite well. Futures have also been used to forecast outcomes in nonfinancial events. Since 1988, the University of Iowa has operated the Iowa Electronic Markets, in which traders buy and sell contracts forecasting results of presidential and other elections. Though the average bet is only $50, the theory is that requiring participants to put real money at risk filters out people who don't know much about the subject. With money at stake, one is likely to bet for the candidate he expects to win, not the one he wants to win. In theory, this market distills the best thinking of knowledgeable participants, the same way the stock market uncovers the consensus about whether a stock will go up or down. And studies have shown that the Iowa market identifies the eventual presidential campaign winner nearly 100 percent of the time. It's more accurate than standard polls about three-quarters of the time. But that doesn't mean a similar market would predict terrorist acts. Investors who bet on the prices of corn or stocks _ or political campaigns _ have access to enormous amounts of information. Before you bet on corn prices six months from now, you can find out how many acres were planted and how much rain has fallen. You'll know how much of last year's crop is still in storage. The less information you have, the weaker your ability to forecast. The Iowa market, for example, is much better at predicting outcomes of U.S. presidential elections than elections for Congress. It's quite poor at forecasting winners in other countries. Investors in the Pentagon's terrorism futures market would have had precious little to work with. The terrorists certainly wouldn't volunteer information. Our intelligence agencies don't seem to know much about what terrorist groups are up to, and they aren't going to make public the bits they do know. Critics were right _ the terrorism futures market was a cockamamie scheme. Good riddance to it.