Let Prediction Markets Fight Terrorism

The Commodity Futures Trading Commission (CFTC)'s recent request for comments about the regulation of prediction markets includes a number of specific questions. I am not sure whether I will manage to write up answers to all of them before the July 7 deadline, but question in particular—question 14—has attracted my attention. The CFTC there asks, "Should certain underlying events or measures--such as those based on assassinations or terrorist activities—be prohibited altogether due to the social perception and impact of such events? What statutory or other legal basis would support this treatment?"

I answer the first part of question 14, "No," (and thus need not answer the second part). I doubt that the CFTC wants to hear that sort of reply, frankly; I instead suspect that it wants a legal excuse to avoid the sort of political firestorm that followed the Pentagon's proposal to create a Policy Analysis Market that included claims about assassinations and terrorist events. My draft answer to question 14 explains why I'm willing to risk disappointing the CFTC:

The CFTC should not forbid trading in claims based on assassinations, terrorist activities, or other criminal acts. Because event markets would offer only relatively thin and traceable trading, they would not offer an attractive investment option to anybody planning to profit from wrongdoing. A would-be terrorist would risk revealing both his plans and his identity if, for instance, he invested in a contract predicting another 9/11. He would instead find it more safe and profitable to simply short certain publicly traded stocks.

Furthermore, event markets in terrorist or criminal acts might benefit the public by revealing life-saving information. Suppose, for instance, that an anthropologist's study of corrido culture convinced her that narcoterrorists had begun planning military raids on border checkpoints in Arizona and California. If she had the opportunity to buy terrorist event claims, she might both profit from her research and tip us all off about looming trouble. Sound public policy suggests that we should encourage that sort of trading—not forbid it.

To judge from their reactions to the Policy Analysis Market proposed by the Pentagon in 2003, politicians might need to learn more about the benefits of using trading to help predict assassinations or other terrorist events. That poses a public relations problem, however—not a legal one. The CFTC thus has no sound reason to presumptively forbid trading in contracts related to such events.

Notably, my answer to question 14 differs sharply from the answer offered by Jed Christiansen. He said, "There should never be any incentive to break a law, so there should never be any contracts that would pay someone if a law was broken." I disagree, of course, but I thank him for stimulating me to offer an alternative take.

[Crossposted at Agoraphilia and Midas Oracle.]