Future Perfect

For years, prediction markets have forecast elections with eerie accuracy. Now, they’re coming soon to a policy near you.

Want to know who the next U.S. president will be? Forget the daily barrage of polls: For 20 years, an online project run out of the University of Iowa has predicted the winner of presidential elections more accurately than opinion surveys.

It's the stuff of pundits dreams, but the Iowa Electronic Markets (IEM) is the only legal market of its type in the United States. Antigambling laws prevent other such markets from taking online bets with real money, a sanction the IEM avoids because it is primarily used for research. But soon, the IEM might have competition. This summer, corporations and economists lobbied the U.S. Commodity Futures Trading Commission (CFTC) on one of the regulatory body's upcoming decisions: Should more prediction markets like the IEM be permitted on U.S. soil?

Proponents say such a move would be far more than a good gamble. "The net result [of legalizing the markets] will be to provide more accurate public assessments of political risks around the world," the Eurasia Group, a risk-assessment consulting firm, argued in a letter to the CFTC this summer. "This is an unmitigated public good."

News about the ruling could come before 2009, says Bruce Fekrat, special counsel at the CFTC. But whatever the commission decides in the short term, one forecast is clear: With or without real money, political prediction markets are coming to America.

Many in the policy world are already convinced about prediction markets reliability. Google uses them to forecast the impact and success of business decisions; public-health experts use markets to track influenza strains. They are not a crystal ball, but based on the academic research, prediction markets are better [forecasters] than anything else available, boasts John Delaney, CEO of prediction market Intrade. Indeed, a recent study published in the International Journal of Forecasting found that the IEM came closer to predicting election outcomes than opinion polls 74 percent of the time.

The exchanges work much like a stock market. Instead of companies, a trader buys "yes" or "no" contracts for a given event: a Republican will win the White House, or more than 350 people will catch avian flu this year. The price of the stock, which fluctuates as it is bought and sold, translates into the percentage chance that the event will happen. For instance, a price of 62 on a contract betting that the Guantnamo Bay prison will be shuttered by December 2009 means traders collectively think the closing has a 62 percent probability. Where money is not allowed, companies use fake currencies (such as the Gooble of Google) or prizes as an incentive to trade. Other markets avoid U.S. restrictions altogether by basing their servers abroad, as does Intrade, operating from Ireland.

Economists like the markets because they are fast, fluid, and efficient. "You look at the price of Obama stock [trading at 87.6 on Intrade as of Oct. 27] vs. the McCain stock [trading at 12.6]," offers David Perry, president of prediction markets consulting firm Consensus Point," and it is so easy to interpret." There is also a strong incentive for knowledgeable traders to put their money where their mouth is: If they're right, theres a payoff when the contract comes due.

Predictions of specific political events have also met with some success. In the lead-up to Saddam Hussein's capture in late 2003, an Intrade contract predicted the event two days before information about the ousted dictators imminent capture became publicly available. "There was an incentive for somebody who has private information to put it in the public domain," Delaney explains. Traders on Intrade also correctly forecast the resignation of U.S. Defense Secretary Donald Rumsfeld.

A twist on the predictions model might be consulting firms setting up political futures markets. If the CFTC rule change goes through, client companies could buy contracts to hedge against unforeseen events that could damage their business, be it the collapse of the Bolivian government or a renewed outbreak of war in Georgia. "Political risks could mean tens of thousands of dollars to me whether I like it or not, and there will be some firms interested in offering those [predictions as] products," explains Justin Wolfers, an economist at the University of Pennsylvania's Wharton School.

If prediction markets are so great, why not legalize? The question may be just as much a moral as a regulatory one. Take the case of the Pentagons Defense Advanced Research Projects Agency (DARPA), which in 2003 tried to start a prediction market that included 10,000 traders. The idea was to forecast political events in the Middle East -- such as Palestinian leader Yasir Arafat's assassination -- allowing the United States to tailor its security and diplomatic policies accordingly.

But betting on the death of a leader or another country's demise raised qualms that Congress could not ignore. One senator who helped spike the program called it "ridiculous" and "grotesque." Economists worried too. Nobel laureate Joseph Stiglitz feared the market would create an incentive for bad behavior: Terrorist groups such as Hamas could get a payoff by betting that a terrorist attack would occur, and then carrying it out. Manipulation was another concern. Investors might try to influence real-world events, as an investor recently did by pushing the price of John McCains Intrade "stock" up 10 points, perhaps in the hopes of boosting the Republican presidential nominee's chances on Nov. 4.

The markets' supporters claim such criticisms usually dont stand up. If terrorists, for example, placed bets on their upcoming missions, the trades would inform policymakers of the impending doom -- the very motive for creating the markets in the first place. "It's like leaving their business card at the crime scene," says Delaney, the Intrade CEO. Manipulation, too, is easy to track and costly for the manipulator. An investigation quickly pinpointed the inflationary McCain trader, who surely lost thousands of dollars.

Since DARPA's 2003 debacle, just one other government entity has dabbled in the markets. The Joint Planning and Development Office, a body set up to coordinate between government agencies, hopes to use prediction markets in designing NextGen, a revamped air-traffic control system for the United States set to launch in 2025. Traders from the airline industry, government bodies, and technical firms will be able to bet on when interim deadlines can be met, giving managers a more accurate timeline of progress. As a bonus, the markets will help the bureaucracy take into account factors such as changes of administration and shifting congressional priorities. "Politics is very hard to talk about for a civil servant. So the market allows you to avoid difficult discussions," says Yuri Gawdiak, the NASA engineer charged with setting up the system.

"Prediction markets can also help officials judge whether certain policies will work," says Robin Hanson, chief scientist at Consensus Point and an economist at George Mason University who worked on the Pentagon's futures project. If you are imagining a major initiative in African health, or if you're trying to stabilize a trade agreement, you can ask the markets whether or not you can expect success.

Cleaning up Wall Street, Delaney argues, might be another good use for prediction markets. In lieu of traditional ratings agencies such as Standard & Poor's or Moody's, for instance, the markets could be used to evaluate corporate debt or predict bank failures: As of Oct. 22, Intrade gave a 94 percent chance that more than 15 U.S. banks would collapse by mid-December, and a 57 percent chance that the number would exceed 20.

Hanson, however, worries the financial crisis might prevent the markets from going forward. "A whole bunch of things lately have been blamed on speculators. That doesn't sound like a good environment for authorizing a wider range of [market tools]." But regardless of what U.S. regulators decide, the policy world is jumping in. And while there is no way of knowing the outcome of the CFTCs ruling, there is one tried-and-true way to predict it. How about a market?

Iowa Electronic Markets


The Worst of the Worst?

They told us to overlook the abuses because Guantánamo housed “the worst of the worst.” But new statistics prove that the vast majority of prisoners detained there never posed any real risk to America at all.

When a federal judge ordered the release of 17 Guantanamo Bay detainees earlier this month, it was the first real chance in the seven-year history of the prison camp that any of the prisoners might be transferred to the United States. In making his ruling, the judge categorically rejected the Bush administration's claim that any of the released prisoners, who are all Chinese Muslims, were enemy combatants or posed a risk to U.S. security. The decision was temporarily suspended by the appeals court, but the judge was on solid ground.

Controversy over the Bush administration's policy to detain enemy combatants at Guantanamo has raged since the facility opened in 2002 -- fueled primarily by the lack of legal protections afforded the detainees and allegations of their mistreatment. Often overlooked, however, is the fact that most of these detainees have never posed any real risk to America, for the simple reason that the vast majority of them were never enemy combatants in the first place. Indeed, striking new data we have obtained show that, if anything, the 17 innocent Chinese men are far from exceptional.

Before we get to the new statistics corroborating this startling fact, a quick review of how the detainees got to Guantanamo in the first place is helpful. Given the fog of propaganda surrounding the Guantanamo prisoners -- whom former Secretary of Defense Donald Rumsfeld once famously described as the worst of the worst -- you might be surprised to learn that, according to the Pentagon itself, only 5 percent of detainees at the prison were ever apprehended by U.S. forces to begin with. And only another 4 percent were ever alleged to have actually been fighting at all.

Why is that? Almost all of the detainees were turned over to U.S. forces by foreigners, either with an ax to grind or, more often, for a hefty bounty or reward. After U.S. forces invaded Afghanistan in late 2001, they doled out rewards of about $5,000 or more to Pakistanis and Afghans for each detainee turned over. Contrary to standard law enforcement practice, the U.S. military accepted the uncorroborated allegations of the award claimants with little independent investigation.

Now, under much pressure, the Pentagon has released more than 500 detainees over the past three years, while some 270 remain. Based on statistics about the fate of other released prisoners in other contexts, it would not have been surprising if many of these men had resumed their lives of terrorist crimes and illegal warfare. In the United States, more than two thirds of state prisoners are rearrested for serious new crimes within three years, according to the Department of Justice.

Terrorists are criminals too -- indeed, ideologically committed ones. Every reasonable expectation would lead to the conclusion that the rate of recidivism for terrorists should be as high as, if not higher than, it is for other criminals. But guess what happened to the more than 500 terrorist detainees that the United States has released during the last three years? Only a handful has gone back to terrorism or the battlefield.

Almost a quarter of the Guantanamo detainees who have been released have been sent back to Saudi Arabia. Facing a substantial threat from terrorism in their own country, the Saudi authorities have been rigorous -- some might say harsh -- in imprisoning and punishing any terrorist deemed a danger. Yet in new statistics provided to us by the Ministry of Interior in Riyadh, zero of the 121 Guantanamo detainees received by the Saudis were deemed dangerous and ineligible for release.

It gets worse. Of those detainees returned to Saudi Arabia from Guantanamo, more than half have been released and are now free, most after spending a period of time in a halfway house designed to promote a smooth return to society. Only six former Guantanamo detainees have been rearrested in Saudi Arabia for any reason -- an astonishingly low recidivism rate of less than 9 percent among those released.

Although the Saudi efforts to reintegrate these prisoners into society are certainly commendable, the only reasonable explanation for such a low recidivism rate is that the detainees were never guilty of terrorist acts in the first place. For years, Pentagon officials have claimed that the recidivism rate for prisoners released from Guantanamo is about 7 percent. Information released in May by the Department of Defense further buttresses the Saudi findings of a very low recidivism rate. The department's list of named released detainees who have subsequently engaged in militant or terrorist activities anywhere in the world shows that 12 have done so, a recidivism rate of just 2 percent. In fact, the Pentagon can cite only six instances in which an inmate released from Guantanamo actually took up arms against the United States.

When recidivism rates for criminals typically run in the more than 60 percent range, and when at Guantanamo you have a rate in only the single digits, you don't have much of a criminal (or in this case terrorist) population to begin with. We are hardly saying there are no terrorists at Guantanamo. Khalid Sheikh Mohammed, the operational commander of the 9/11 attacks, and others who were transferred there from secret overseas Central Intelligence Agency prisons in 2006 are certainly members of al Qaeda's hard core.

What we are saying is that new statistics from the Saudi Ministry of Interior, corroborated by the Pentagon's own findings, show that the overwhelming majority of individuals detained at Guantanamo not only were not terrorists, but were likely innocent of any crime. Given the sad history of detaining men without charges or proof, proven instances of harsh confinement, and now, persuasive evidence to indicate that most detainees were innocent of any terrorist activity, it should be among the highest priorities of the next U.S. president to close Guantanamo promptly.

Guantanamo has been a powerful recruitment tool for extremists and a stain on the reputation of the United States. Now we can say, with little doubt, that it did not even serve to remove terrorists or insurgents from the battlefield.

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