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A controversial plan to set up a “futures market” to use market forces to help predict political upheaval in the Middle East has been scrapped. The Pentagon Tuesday agreed to abandon the plan, the Senate Armed Services Committee chairman said, after Senate Democrats Monday blasted the plan as nothing more than state-sponsored “gambling on terrorism.”

SEN. JOHN WARNER, R-Va., said Monday he spoke by phone with the program’s director, “and we mutually agreed that this thing should be stopped.”

Warner announced the decision not long after Senate Democratic Leader Thomas Daschle took to the floor to denounce the program as “an incentive actually to commit acts of terrorism.”

“This is just wrong,” declared Daschle, D-S.D.

He said they would recommend that the Pentagon not spend any funds already in place for the program and said they would pull the plug on it during House-Senate budget conference committee negotiations later on this year.

TRADING ON TERROR

The conventional wisdom holds that financial markets combine the collective wisdom of the millions of investors who participate in them. Designers of the program were hoping to use that market force to help predict political upheaval in volatile places like the Middle East.

The project was modeled on “futures” exchanges like the Iowa Electronic Markets, a popular Web-based market that lets political junkies place bets — with real money — on the outcome of political elections.

The Policy Analysis Market, which was set to begin signing up “investors” on Friday, was designed to let Middle East experts place bets on political and economic events in the Middle East, according to Charles Polk, president of Net Exchange, a small San Diego, Calif. company hired by the Pentagon’s Defense Advanced Research Projects Agency, or DARPA, to set up the market.

“This isn’t really a terrorism market,” he said Monday. “What we’re trying to do is look forward a year into the future and try to glean some insight into political and economic and military currents in the Middle East.

During the initial test phase, the site was to have been limited to 100 “traders,” chosen from Middle East experts at universities and think tanks, who would get $100 each to buy and sell futures contracts based on events in eight Middle East countries. The online trading system could have eventually been scaled up to include 10,000 traders, Polk said.

Possible “contracts” could include questions like the overthrow of the king of Jordan or the assassination of key figures like Yasir Arafat. These contracts would deal with events in each country related to five major categories: military preparedness, civil stability, economic health, U.S. military involvement and U.S. economic investment, said Polk.

The market was also designed to allow trading in “derivatives” and complex hedging strategies — linking, say, renewed economic growth in Israel to the prospects of approval of Palestinian statehood.

By placing thousands of individual bets, the thinking went, market participants would shape forecasts about future events. The value of the contracts would fluctuate based on market participants’ beliefs about the likelihood of specific events taking place — moving higher if they appeared likely and lower if unlikely. Contracts would expire quarterly and extend a year and a half into the future. Each contract would be fully valued at $1 — the payoff for an accurate prediction.

“You can go into the (Policy Analysis Market) and ask it for that derivative: ‘If U.S. involvement here were to increase, please give me a quote on Syrian civil stability,’” said Polk. “You just ask for a quote.”

But a pair of U.S. Senators doesn’t think this is all such a great idea. On Thursday, Sen. Ron Wyden (D-Ore.) and Sen. Byron Dorgan (D-N.D.) called on the Defense Department to halt the project, saying the “terror-wagering scheme” was a waste of taxpayer dollars — especially after a recent report on Sept. 11 citing breakdowns in conventional intelligence gathering.

“We don’t need a lot of fictional scenarios,” said Wyden in a telephone interview. “We’re not dealing with communication and follow-through in the real world; we think that’s what ought to be the focus, rather than trying to chase down these mysterious scenarios with taxpayers dollars.”

Dorgan described the market as “unbelievably stupid.”

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Among other things, the senators say they’re concerned that terrorists could place bets on the site — and then profit from the accurate prediction of attacks that they carry out. DARPA had promised investors that it wouldn’t be able to identify individuals who signed up for a trading account.

But Polk said that — if terrorists were to bet on their own attack — that would have created exactly the kind of warning signal the Policy Analysis Market is designed to highlight.

“They’re going to move some prices,” he said. “And they’re going to move those prices to levels way above where the market has been striking them. So people are going to say, ‘Why is that price up?’”

Polk said the project was funded through March, 2005. But late Monday, DARPA was already backpedaling the idea.

DARPA officials declined a request for an interview. The agency said in a statement late Monday that “research indicates that markets are extremely efficient, effective and timely aggregators of dispersed and even hidden information. Futures markets have proven themselves to be good at predicting such things as election results; they are often better than expert opinions.” But DARPA said it “will continue to reevaluate the technical promise of the program before committing additional funds beyond Fiscal Year 2003.”

But Wyden said Monday he had already succeeded in amending the defense spending bill to include a provision requiring Congressional approval for the plan to go forward.

“This far-out stuff — at a time when we’re not dealing with the basics — is not a good use of resources and the limited dollars that are available,” he said. “Trading on corn futures is real different than trading on terrorism and atrocity futures. One is morally fine and represents free enterprise, and the other one is morally over the line.”

Backers of the project had hoped that, if it caught on, the Policy Analysis Market could eventually be used by companies trying to hedge the risk of doing business in the Middle East.

But even if the project had gone forward, it’s also not clear whether such a futures market had much of a future beyond a parlor game among Middle East analysts. For one thing, companies already have well-established markets for hedging risks.

Moreover, the volatility of the region would likely wipe out any traders who decided to jump in, according to Jim Placke, a Middle East analyst with Cambridge Energy Research.

“The potential for major losses is always likely to outweigh gains,” he said.

The Associated Press contributed to this report.

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