What Money Can't (Shouldn't) Buy: The Terrorism Futures Market
Suppose there were a death pool that did more than entertain. Imagine a website that enabled you to place a bet not on the death of movie stars but which foreign leaders would be assassinated or overthrown, or on where the next terrorist attack would take place. And suppose the results of this betting pool yielded valuable information that the government could use to protect national security.
In 2003, an agency of the Department of Defense proposed such a website. The Pentagon called it the Policy Analysis Market; the media called it "terrorism futures market". The idea was to let investors buy and sell futures contracts on various scenarious, initially related to Middle East. Would Yasser Arafat be assasinated? Would King Abdullah II Jordan be overthrown? Would Israel be the target of a bioterrorist attack? or Would North Korea launch a nuclear strike?
Since traders would have to back their predictions with their own money, those willing to bet a lot presumably would be the ones with the best information. If futures markets were good at predicting the price of soil, stocks, and soybeans, why not tap their predictive power to anticipate the next terrorist attack?
News of betting site prompted outrage in Congress. Democrats and Republicans alike denounced the futures market, and the Defense Department quickly canceled it. The firestorm of opposition arose partly from doubt that the scheme would work, but mostly from moral revulsion over the prospect of a governmnet-sponsored betting pool on calamitous event. How could the U.S. government invite people to wager and profit on terrorism and death?
The Pentagon did not reply to the moral argument. Instead, it issued a statement setting out the principle behind the project, arguing that futures trading had been effective in predicting not only commodity prices but also elections and the box office success of Hollywood movies: "Research indicates that markets are extremely efficient, effective and timely aggregators of dispersed and even hidden information. Future markets have proven themselves to be good at predicting such tings as election results; they are often bettern than expert opinions."
A number of ecoomists agreed. One wrote that it was "sad to see poor public relations torpedo a potentially important tool for intelligence analysis. The firestorm of protest had prevented a proper appreciation of the program's merits. Financial markets are incredibly powerful aggregators of information, and are often better predictors than traditional methods." Two Stanford economists wrote in The Washington Post. They cited the Iowa Electronic Market, an online futures market that has predicted the results of some presidential elections better tha polls. Another example: orange juice futures. "The futures market in organe juice concentrate is a better predictor of Florida weather than the National Weather Service.
One advantage of prediction markets over traditional intelligence gathering is that markets are not subject to the distortions of information caused by bureaucratic and political pressures. Midlevel experts who know something can go directly to the market and put their money where their convictions are. This coul dyield information that might be suppressed by higher-ups and never see the light of day. Recall the pressures on the CIA, prior to the Iraq War, to conclude that Saddam Hussein possessed weapons of mass destruction. An independent betting website registered greater skepticism on this question than did CIA Director George Tenet, who declard the existence o fsuch weapons a "slam dunk."
But the case for the terrorism future website rested on a bigger, broader claim about the power of markets. With market triumphalism at hight tide, the defenders of the proejct articulated a new precept of market faith that had emerged with the age of finance: not only are markets the most efficient mechanisms for producing and allocating goods; they are also the best way of aggregating information and predicting the future. The virtue of terrorism futures market was that it would poke, rpod and awaken a stubborn intelligence community to the predictive powers of free markets. It would open our eyes to something that decision theorists have known for decades: The probability of events can be measured in terms of the bets people are willing to make.
The claim that free markets are not only efficient but also clairvoyant is striking. Not all economists subscribe to it; some argue that futures markets are good at predicting the price of wheat but have a hard time predicting rare event, such as terrorist attacks. Others maintain that, for intelligence gathering, markets of experts work better tha ones open to the general public. The terrorism future market plan was also questioned on more particular grounds; Would it be open to manipulation by terrorists, who might engage in "insider trading" to profit from an attack, or possibly conceal their plans by shorting terrorist future? And would people really bet on, say, the assassination of the king of Jordan if they knew the U.S. government would use the information to prevent the assassination, thus foiling their wager?
Practicalities aside, what about the moral objection -- that a government-sponsored betting pool on death and disaster is repugnant? Suppose the practical difficulties could be overcome, and a terrorism futures market could be designed that would do a better job than traditional intelligence agencies of predicting assasinations and terrorist attacks. Would the moral repugnance of betting and profiting on death and disaster be sufficient reson to reject it?
If the government were proposing to sponsor a celebrity death pool, the answer would be clear: since it achieves no social good, there is nothing to be said for promoting a callous indifference or, worse, a ghoulish fascination with the death and misfortune of others. Betting schemes such as these are bad enough when conducted by private parties. Wanton wagering on death is corrosive of human sympathy and decency, and should be discouraged, not promoted, by the government.
What makes the terrosim futures market morally more complicated is that, unlike death pools, it purports to do good. Assuming it works, it generates valuable intelligence. This makes it analogous to viaticals. The moral dilemma has the same structure in each case: Should we promote a worthwhile end -- financing medical needs for a dying person; thwarting a terrorist attack -- at the moral cost of giving investors a rooting interest in the death and misfortune of others?
"Yes, of course", replied by an economist who helped conceive the project. "In the name of intelligence, people lie, cheat, steal, and kill. Compared to those sorts of things, our proposal was very mild. We were simply going to take money from some people and give it to others based upon who was right."
But this answer is too easy. It ignores the ways that markets crowd out norms. When senators and editorial writers denounced the terrorism futures market as "outrageous", "repugnant" and "grotesque", they were pointint to the moral ugliness of buying a stake in someone's death and hoping that person will die so you can profit. Althouth there are places in our society where this happens already, having the government sponsor an institution tha tmakes it routine is morally corrupting.
Perhaps under dire circumstances, this would be a moral price worth paying. Argumetns from corruption are not always decisive, but they direct our attention to a moral consideration tha tmarket enthusiasts often miss. If we were convinced that a market in terrorist futures was the only way, or the best way , to protect the country from terrorist attack, we might decide to live with the debased moral sensibilities such a market would promote. But that would be a devil's bargain, and it would be imporatnat to remain alive to its repugnance.
When markets in death become familiar and routine, the moral opprobrium is not easty to retain. This is important to bear in mind at a time when life insurance is becomoing, as it was in eighteenth-century England, an instrument of speculation. Today, betting on the lvies of strangers is no longer an isolated parlor game but a major industry.
The Lives of Strangers
Life-extending AIDS drugs were a blessing for health but a curse for the viatical industry. Investors found themsleves stuck paying premiums on life insurance policies that failed to "mature" so promptly as expected. If the business was to survive, viatical brokers needed to fine more reliable deaths to invest in. After looking to cancer patients and others with terminal illnesses, they came up with a bolder idea: Why limit the business to people with disease? Why ot buy life insurance policies from healthy senior citizens willing to cash them in?
Alan Buerger was a pioneed of the new industry. In early 1990s, he had sold janitors insurance to corporations. When Congress cut back the tax advantages of janitors insurance, Buerger considered moving into viaticals. But then it occurred to him that healthy, wealthy seniors offered a bigger, more promising market. "I felt like I was struck by lighning", he told Wall Street Journal.
In 2000, he bagan buyin life insurance policies from people age sixty-five and older, and selling them to investors. The business works like the viatical business, except that the life expectancies are longer, and the value of the policy is typically higher, usually $1 million or more. Investors buy the policies from people who no longer want them, pay the premiums, and collect the death benefit when the poeple die. To avoid the taint that came to be associated with viaticals, this new business calls itself the "life settlement" industry. Buerger's company, Conventry First, is one of the most successful in the business.
The life settlement industry presents itself as "a free market for life insurance." Previously, people who no longer wanted or needed their life insurance policies had no choice but to leth them lapse, or in some cases to cash them in with the insurance company for a small surrender amount. Now they can get more for their unwanted policies by selling them off to investors.
It sounds like a good deal all around. Seniors get a decent price for their unwanted life insurance policies, and investors reap the benefits when the policies come due. But the secondary market in life insurance has bred a number of controversies and a spate of lawsuits.
One controversy arises from the eocnomics of the insurance industry. Insurance companies don't like life settlements. In setting premiums, they have long assumed that a certain number of people will drop their policies before they die. Once the children are grown and one's spouse is provided form policy holders often stop paying premiums and let their policies lapse. In fact, almost 40% of life insurance policies result in no death benefit payout. But as more policy holders sell their policies to investors, fewer policies will lapse, and the insurance companies will have to pay out more death benefits (i.e., to investors who keep paying the premiums and eventually collect).
Another controversy involves the moral awkwardness of betting agianst life. With life settlements as with viaticals, the profitability of the investment depends on when the person dies. In 2010, The Wall Street Journal reported that Life Partners Holdings, a life settlement company in Texas, had systematically udnerestimated the life expectancy of the poeple whose policies they sold to investors. For example, the company sold investors a $2 million insurance policy on the life of a 79 year old Idaho rancher, claiming he had only two to four years to live. More than five years later, the rancher, then 84, was still going storng, running on a treadmill, lifting weights, and chopping wood. "I'm healthy as a horse. There's going to be a lot of disappointed investors", he said.
Death Bonds
In 2009, The NY Times reported that Wall Street investment banks planned to buy life settlements, package them into bonds, and resell the bonds to pension funds and other big investors. The bonds would generate an income stream from the insurance payouts that came due as original policy holders died. Wall Street would do for death what, over the past few decades, it had been doing for home mortages. Goldman Sachs has developed a tradable index of life settlements, enabling investors to bet on whether poeple will live longer than expected or die sooner than planned. Credit Suisse is creating a financial assembly line to buy large numbers of life insurance policies, package and resell them -- just as Wall Street firms did with subprime securities. With $26 trillion of life insurance policies in existence in the U.S., and a growing trade in life settlements, the death market offers hope for a new financial product to offset the lost revenue from the collapse of mortgage securities market.
Although some rating agencies remain to be convinced, at least one believes it is possible to create a bond based on life settlements that minimizes risk. Just as mortgage securiteis bundle loans from different regions of the country, a bond backed by life settlements could bundle policies on people with range of diseases -- leukemia, lung cancer, heart disease, breast cancer, diabets, Alzheimer's. A bond backed by this diversified portfolio of ailments would enable investors to rest easy, because the discovery of a cure for any one disease would not cause the bond price to tank.
AIG, the insurance giant whose complex financial dealings helped bring on the 2008 financial crisis, has also expressed interest. As an insurance company, it has opposed the life settlement industry and fought it in court. But it has quietly bought up $18 billion of the $45 billion in life settlement policies currently on the market and now hopes to package them into securities and sell them as bonds.
What then is the moral status of death bonds? In some ways, it is comparable to the death bets that underline them. If it's morally objectionable to wager on the lives of human beings and to profit from their deaths, then death bonds share this defect with the various practices we've considered -- janitor insurance, viaticals, death pools, and all purely speculative trade in life insurance. It might be argued that the a nonymity and abstractness of death bonds reduces the corrosive effect on our moral sensibilities to some degree. Once life insurance policies are bundled in vast packages, then slice and diced and sold off to pension funds and college endowments, no investor retains a rooting interest in the death of any particular person.
Admittedly, death bond prices would fall if national health policy, environmental standards, or improved eating and exercise habits led to better health and longer lives.
Sometimes we decide to live with a morally corrosive market practice for the sake of the social good it provides. Life insurance began as a compromise of this kind. To protect families and businesses against the financial risks of an untimely death, societies came reluctantly to the conclusion, over the past two centuries, that those with an insurable interest in a person's life should be permitted to make a wager with death. But the speculative temptation proved difficult to contain.
In 2003, an agency of the Department of Defense proposed such a website. The Pentagon called it the Policy Analysis Market; the media called it "terrorism futures market". The idea was to let investors buy and sell futures contracts on various scenarious, initially related to Middle East. Would Yasser Arafat be assasinated? Would King Abdullah II Jordan be overthrown? Would Israel be the target of a bioterrorist attack? or Would North Korea launch a nuclear strike?
Since traders would have to back their predictions with their own money, those willing to bet a lot presumably would be the ones with the best information. If futures markets were good at predicting the price of soil, stocks, and soybeans, why not tap their predictive power to anticipate the next terrorist attack?
News of betting site prompted outrage in Congress. Democrats and Republicans alike denounced the futures market, and the Defense Department quickly canceled it. The firestorm of opposition arose partly from doubt that the scheme would work, but mostly from moral revulsion over the prospect of a governmnet-sponsored betting pool on calamitous event. How could the U.S. government invite people to wager and profit on terrorism and death?
The Pentagon did not reply to the moral argument. Instead, it issued a statement setting out the principle behind the project, arguing that futures trading had been effective in predicting not only commodity prices but also elections and the box office success of Hollywood movies: "Research indicates that markets are extremely efficient, effective and timely aggregators of dispersed and even hidden information. Future markets have proven themselves to be good at predicting such tings as election results; they are often bettern than expert opinions."
A number of ecoomists agreed. One wrote that it was "sad to see poor public relations torpedo a potentially important tool for intelligence analysis. The firestorm of protest had prevented a proper appreciation of the program's merits. Financial markets are incredibly powerful aggregators of information, and are often better predictors than traditional methods." Two Stanford economists wrote in The Washington Post. They cited the Iowa Electronic Market, an online futures market that has predicted the results of some presidential elections better tha polls. Another example: orange juice futures. "The futures market in organe juice concentrate is a better predictor of Florida weather than the National Weather Service.
One advantage of prediction markets over traditional intelligence gathering is that markets are not subject to the distortions of information caused by bureaucratic and political pressures. Midlevel experts who know something can go directly to the market and put their money where their convictions are. This coul dyield information that might be suppressed by higher-ups and never see the light of day. Recall the pressures on the CIA, prior to the Iraq War, to conclude that Saddam Hussein possessed weapons of mass destruction. An independent betting website registered greater skepticism on this question than did CIA Director George Tenet, who declard the existence o fsuch weapons a "slam dunk."
But the case for the terrorism future website rested on a bigger, broader claim about the power of markets. With market triumphalism at hight tide, the defenders of the proejct articulated a new precept of market faith that had emerged with the age of finance: not only are markets the most efficient mechanisms for producing and allocating goods; they are also the best way of aggregating information and predicting the future. The virtue of terrorism futures market was that it would poke, rpod and awaken a stubborn intelligence community to the predictive powers of free markets. It would open our eyes to something that decision theorists have known for decades: The probability of events can be measured in terms of the bets people are willing to make.
The claim that free markets are not only efficient but also clairvoyant is striking. Not all economists subscribe to it; some argue that futures markets are good at predicting the price of wheat but have a hard time predicting rare event, such as terrorist attacks. Others maintain that, for intelligence gathering, markets of experts work better tha ones open to the general public. The terrorism future market plan was also questioned on more particular grounds; Would it be open to manipulation by terrorists, who might engage in "insider trading" to profit from an attack, or possibly conceal their plans by shorting terrorist future? And would people really bet on, say, the assassination of the king of Jordan if they knew the U.S. government would use the information to prevent the assassination, thus foiling their wager?
Practicalities aside, what about the moral objection -- that a government-sponsored betting pool on death and disaster is repugnant? Suppose the practical difficulties could be overcome, and a terrorism futures market could be designed that would do a better job than traditional intelligence agencies of predicting assasinations and terrorist attacks. Would the moral repugnance of betting and profiting on death and disaster be sufficient reson to reject it?
If the government were proposing to sponsor a celebrity death pool, the answer would be clear: since it achieves no social good, there is nothing to be said for promoting a callous indifference or, worse, a ghoulish fascination with the death and misfortune of others. Betting schemes such as these are bad enough when conducted by private parties. Wanton wagering on death is corrosive of human sympathy and decency, and should be discouraged, not promoted, by the government.
What makes the terrosim futures market morally more complicated is that, unlike death pools, it purports to do good. Assuming it works, it generates valuable intelligence. This makes it analogous to viaticals. The moral dilemma has the same structure in each case: Should we promote a worthwhile end -- financing medical needs for a dying person; thwarting a terrorist attack -- at the moral cost of giving investors a rooting interest in the death and misfortune of others?
"Yes, of course", replied by an economist who helped conceive the project. "In the name of intelligence, people lie, cheat, steal, and kill. Compared to those sorts of things, our proposal was very mild. We were simply going to take money from some people and give it to others based upon who was right."
But this answer is too easy. It ignores the ways that markets crowd out norms. When senators and editorial writers denounced the terrorism futures market as "outrageous", "repugnant" and "grotesque", they were pointint to the moral ugliness of buying a stake in someone's death and hoping that person will die so you can profit. Althouth there are places in our society where this happens already, having the government sponsor an institution tha tmakes it routine is morally corrupting.
Perhaps under dire circumstances, this would be a moral price worth paying. Argumetns from corruption are not always decisive, but they direct our attention to a moral consideration tha tmarket enthusiasts often miss. If we were convinced that a market in terrorist futures was the only way, or the best way , to protect the country from terrorist attack, we might decide to live with the debased moral sensibilities such a market would promote. But that would be a devil's bargain, and it would be imporatnat to remain alive to its repugnance.
When markets in death become familiar and routine, the moral opprobrium is not easty to retain. This is important to bear in mind at a time when life insurance is becomoing, as it was in eighteenth-century England, an instrument of speculation. Today, betting on the lvies of strangers is no longer an isolated parlor game but a major industry.
The Lives of Strangers
Life-extending AIDS drugs were a blessing for health but a curse for the viatical industry. Investors found themsleves stuck paying premiums on life insurance policies that failed to "mature" so promptly as expected. If the business was to survive, viatical brokers needed to fine more reliable deaths to invest in. After looking to cancer patients and others with terminal illnesses, they came up with a bolder idea: Why limit the business to people with disease? Why ot buy life insurance policies from healthy senior citizens willing to cash them in?
Alan Buerger was a pioneed of the new industry. In early 1990s, he had sold janitors insurance to corporations. When Congress cut back the tax advantages of janitors insurance, Buerger considered moving into viaticals. But then it occurred to him that healthy, wealthy seniors offered a bigger, more promising market. "I felt like I was struck by lighning", he told Wall Street Journal.
In 2000, he bagan buyin life insurance policies from people age sixty-five and older, and selling them to investors. The business works like the viatical business, except that the life expectancies are longer, and the value of the policy is typically higher, usually $1 million or more. Investors buy the policies from people who no longer want them, pay the premiums, and collect the death benefit when the poeple die. To avoid the taint that came to be associated with viaticals, this new business calls itself the "life settlement" industry. Buerger's company, Conventry First, is one of the most successful in the business.
The life settlement industry presents itself as "a free market for life insurance." Previously, people who no longer wanted or needed their life insurance policies had no choice but to leth them lapse, or in some cases to cash them in with the insurance company for a small surrender amount. Now they can get more for their unwanted policies by selling them off to investors.
It sounds like a good deal all around. Seniors get a decent price for their unwanted life insurance policies, and investors reap the benefits when the policies come due. But the secondary market in life insurance has bred a number of controversies and a spate of lawsuits.
One controversy arises from the eocnomics of the insurance industry. Insurance companies don't like life settlements. In setting premiums, they have long assumed that a certain number of people will drop their policies before they die. Once the children are grown and one's spouse is provided form policy holders often stop paying premiums and let their policies lapse. In fact, almost 40% of life insurance policies result in no death benefit payout. But as more policy holders sell their policies to investors, fewer policies will lapse, and the insurance companies will have to pay out more death benefits (i.e., to investors who keep paying the premiums and eventually collect).
Another controversy involves the moral awkwardness of betting agianst life. With life settlements as with viaticals, the profitability of the investment depends on when the person dies. In 2010, The Wall Street Journal reported that Life Partners Holdings, a life settlement company in Texas, had systematically udnerestimated the life expectancy of the poeple whose policies they sold to investors. For example, the company sold investors a $2 million insurance policy on the life of a 79 year old Idaho rancher, claiming he had only two to four years to live. More than five years later, the rancher, then 84, was still going storng, running on a treadmill, lifting weights, and chopping wood. "I'm healthy as a horse. There's going to be a lot of disappointed investors", he said.
Death Bonds
In 2009, The NY Times reported that Wall Street investment banks planned to buy life settlements, package them into bonds, and resell the bonds to pension funds and other big investors. The bonds would generate an income stream from the insurance payouts that came due as original policy holders died. Wall Street would do for death what, over the past few decades, it had been doing for home mortages. Goldman Sachs has developed a tradable index of life settlements, enabling investors to bet on whether poeple will live longer than expected or die sooner than planned. Credit Suisse is creating a financial assembly line to buy large numbers of life insurance policies, package and resell them -- just as Wall Street firms did with subprime securities. With $26 trillion of life insurance policies in existence in the U.S., and a growing trade in life settlements, the death market offers hope for a new financial product to offset the lost revenue from the collapse of mortgage securities market.
Although some rating agencies remain to be convinced, at least one believes it is possible to create a bond based on life settlements that minimizes risk. Just as mortgage securiteis bundle loans from different regions of the country, a bond backed by life settlements could bundle policies on people with range of diseases -- leukemia, lung cancer, heart disease, breast cancer, diabets, Alzheimer's. A bond backed by this diversified portfolio of ailments would enable investors to rest easy, because the discovery of a cure for any one disease would not cause the bond price to tank.
AIG, the insurance giant whose complex financial dealings helped bring on the 2008 financial crisis, has also expressed interest. As an insurance company, it has opposed the life settlement industry and fought it in court. But it has quietly bought up $18 billion of the $45 billion in life settlement policies currently on the market and now hopes to package them into securities and sell them as bonds.
What then is the moral status of death bonds? In some ways, it is comparable to the death bets that underline them. If it's morally objectionable to wager on the lives of human beings and to profit from their deaths, then death bonds share this defect with the various practices we've considered -- janitor insurance, viaticals, death pools, and all purely speculative trade in life insurance. It might be argued that the a nonymity and abstractness of death bonds reduces the corrosive effect on our moral sensibilities to some degree. Once life insurance policies are bundled in vast packages, then slice and diced and sold off to pension funds and college endowments, no investor retains a rooting interest in the death of any particular person.
Admittedly, death bond prices would fall if national health policy, environmental standards, or improved eating and exercise habits led to better health and longer lives.
Sometimes we decide to live with a morally corrosive market practice for the sake of the social good it provides. Life insurance began as a compromise of this kind. To protect families and businesses against the financial risks of an untimely death, societies came reluctantly to the conclusion, over the past two centuries, that those with an insurable interest in a person's life should be permitted to make a wager with death. But the speculative temptation proved difficult to contain.
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