Stiglitz re terrorism futures market

[pynchonoid]

...in this context it might also be interesting to
revisit what Pynchon has written re actuaries and
probabilities in his novels, especially in Vineland
and GR...

COMMENTARY
Terrorism: There's No Futures in It
 Administration has taken market fundamentalism to an
absurd low.
 
	 
 	 	 By Joseph E. Stiglitz, Joseph E. Stiglitz, an
economics professor at Columbia University, was
chairman of the Council of Economic Advisors under
President Clinton. He was awarded the Nobel Prize in
economics in 2001.

The Bush administration's naive belief in free-market
economics reached a new level of absurdity this week
with the proposal to create a futures market in
terrorism. The argument behind the proposal was
simple: Information is valuable, and information about
a possible terrorist attack is particularly valuable. 

[...] Studies have shown that in some instances prices
negotiated today on a futures market can serve as a
reasonably good predictor of what the price will be on
the day of delivery. Consider the futures market for
wheat in September. If today's price in that market is
$3.39 per bushel, then $3.39 is a good prediction of
what the price for wheat will be. Economists refer to
this as the "price discovery" function and believe
such markets may not only predict the price of corn or
wheat but also election outcomes.

Almost 30 years ago, Sanford Grossman and I
investigated theoretically the validity of these
claims. We focused on competitive markets in which we
assumed participants had some relevant information.
For instance, a farmer knows something about his own
crop, so if he participates in a futures market he
will bring his knowledge to bear on that market.
Voters who participate in a futures market also bring
relevant information — whom they and their friends are
voting for — and that is why futures markets may
predict presidential elections reasonably well. 

But there are severe limitations in the ability of
markets to provide accurate predictions; for instance,
where markets have few participants and can be easily
manipulated, or where there are large asymmetries of
information, with some participants (the few large
international chocolate producers, for example, in the
cocoa futures market) having far more information than
others.

Futures markets provide insurance as well as
information: They enable a farmer/trader to reduce the
risks he faces resulting from the fluctuations in
commodity prices. But by providing "insurance" for
participants, futures markets can also create the
long-noted "moral hazard" problem — the notion that
insurance can alter incentives. Someone who has
insured his house for 110% of its value has an
incentive to set it afire.

What, then, are we to make of the short-lived proposal
by the Pentagon's Defense Advanced Research Projects
Agency for a terrorism futures market? Did it reflect
a brilliant breakthrough, an extension of market
processes into an area where markets, by themselves,
feared to tread? Or did it represent market
fundamentalism descending to a new level of absurdity?
Under the proposal, which the administration disowned
almost as soon as it became public, participants would
have been betting, in effect — and perhaps profiting —
on such potential events as an attack by North Korea
or an assassination of Yasser Arafat.

Of course, no one expected DARPA's John M. Poindexter
— notorious for his eventually overturned conviction
for lying to Congress about Irangate — to approach the
problem from the perspective of economic theory. But
what was he thinking? Did he believe there is
widespread information about terrorist activity not
currently being either captured or appropriately
analyzed by the "experts" in the FBI and the CIA? Did
he believe that the 1,000 people "selected" for the
new futures program would have this information? If
so, shouldn't these people be investigated rather than
rewarded? 

But there are more fundamental problems with the idea.
If trading is anonymous, then it could be subject to
manipulation, particularly if the market has few
participants — providing a false sense of security or
an equally dangerous false sense of alarm. If trading
is not anonymous, then anyone with information about
terrorism would be, understandably, reluctant to trade
on it. In that case, the market would not serve its
purpose. 

Now consider the second function of futures markets —
insurance. The Pentagon's proposal would have allowed
those with the sophistication and money to "hedge"
against the threat of terrorism, financially at least,
leaving the rest of Americans fully exposed! Though we
have come to expect such inequities from the Bush
administration's tax policies, surely the U.S.
government should be concerned with the exposure of
all Americans to terrorism. 

Notice that in proposing this idea, at least the
Bushies are recognizing the limitations of the
innovative capacity of markets. If this is such a good
idea, why haven't the markets created it on their own?

Interestingly, the group promoting the idea, DARPA,
had — before Bush took over — a credible record of
promoting some important innovations, including an
important role in the early days of the Internet. 
In its own peculiar way, the administration has once
again recognized the limitations of markets — as it
did with the airline bailouts, steel tariffs and
agriculture subsidies. But once again, the lack of
intellectual foundation or a firm grasp of economic
principles — or the pursuit of other agendas — has led
to a proposal that almost seems a mockery of itself. 


<http://www.latimes.com/news/printedition/opinion/la-oe-stiglitz31jul31,1,2672394.story>

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