I’ve been interested in the history of the invention we call “money”, but the fascination doesn’t stop at the origination of this essential tool of modern commerce. Because two seconds after money was invented, some ancient farmer in Mesopotamia turned to his neighbor and said, “I’ll bet you four cows it doesn’t rain tomorrow”.
Gambling has been found in cultures dating back thousands of years. Implements from 2300 BC have been found in China. Pyramids in Giza describe gambling. Ivory dice found in Egypt date to over 3500 years ago. It seems that along with our ability to think into the future, we concurrently developed the idea that we could profit from prediction. The degree of sophistication, complexity and creativity in constructing these bets has reached a new zenith in the last couple of decades.
By now, most people who read business news are becoming educated on the subject of “derivatives”, i.e., types of financial bets that are derived from some underlying asset, whether or not the asset itself is owned by the person placing the bet, or by the person offering the bet. Mortgage-backed securities are an example of the former, and index funds are an example of the latter. A more recent term for derivatives is now “structured investment vehicle” or SIV. It’s interesting to note that the financial institutions who sell SIV’s customarily strive to invent new deal structures and associated acronyms so that the fundamental economics of the transaction are less than transparent. In fact, opacity seems to be the goal. Which reminds one of another game of chance where the value is hidden through manipulation of perceptions: the three-card Monty. But instead of a card table on a street corner, the modern hucksters shuffle their cards on the fiftieth floor, behind mahogany desks, wearing Armani. And the stakes are much higher. The stakes are, in fact, nothing less than our collective future.
But the evolution of gambling sophistication doesn’t stop there. In 1988, three enterprising economists from the University of Iowa decided to test whether the economic theory of market “efficiency” could be applied to political contests, possibly beating the predictive ability of polls to identify the winner. The idea was that, if an “efficient market” truly held the sum total of information about an asset in the price, then establishing a trading platform for taking the bets would result in a better tool for determining who would win an election than asking people who they were going to vote for. Professors Neumann, Nelson and Forsythe established the Iowa Electronic Market (IEM), got a special exemption from regulatory agencies because it was for research purposes, and started trading. From 1988 to 2004, the IEM beat the polls 74% of the time.
This academic line of inquiry, notably hatched by the Iowa academics over a few beers, has advanced significantly since 1988. The term now used for the idea is “prediction markets”, which is to “gambling” as “pre-texting” is to “lying”. Prediction markets now include trading on events ranging from box office receipts for various movies, to whether or not the U.S. or Israel will launch an air strike on Iran within a “futures contract” time frame. This last example, brokered by an online company called Intrade, is an example of a whole new way of trading. Intrade is a real-money transaction site that allows bets on everything from who will win the Democratic primary, to where and when the next earthquake will strike, to how long it will take the Avian flu to pass from one human to another.
I think it’s only a matter of time before these “prediction markets” begin packaging the underlying bets placed on a wide variety of events, and selling them to a secondary market as an SIV, bundled with prime debt, rated AAA by Moody’s and listed quietly on some municipality’s pension asset list. The investment banking firms will no doubt create an attractive acronym from an important sounding product phrase: Securitized Collateral Asset Markets.