It wasn’t until Professor Greenstone began examining the financial markets’ pricing of Iraqi government debt that he had his eureka moment. It was immediately clear that the bond market — which, historically, has often been an early indicator of the demise of a political system — was pessimistic about the Iraqi government’s chances for survival.

First, some background … the Iraqi government issued about $3 billion of new bonds in January 2006. These dollar-denominated bonds pay 2.9 percent twice a year and mature in 2028, paying the face value of $100.

To say the least, the market for these bonds is not robust: as of last week, a bond with a face value of $100 was trading at around $60. Professor Greenstone calculated that, from the markets’ standpoint, the implied default risk over the life of the bond was about 80 percent.

The important point is that anyone who owns one of these Iraqi bonds has to decide each day whether the Iraqi government is likely to be functional enough to make its debt payments, or will default along the way. All else being equal, if the surge policy is effective, it ought to be raising the market price of these bonds.

Bondholders “aren’t politically motivated,” Professor Greenstone said. “They don’t have to rationalize their previous statements or justify their votes from years past. All they care about is whether there will be a functioning Iraq in the future such that they will receive their payments.” At a certain price, most securities will find a buyer, and there are still buyers for Iraqi bonds. But the price they are willing to pay is very low.

Goolsbee tosses in a few examples which show, in his words, ” the collective wisdom of financial markets has proved remarkably adept at evaluating events and predicting the future, even the turning points of war“:

During the American Civil War, for example, when Confederate forces lost at Gettysburg, Confederate cotton bonds traded in England dropped by about 14 percent. During World War II, German government bonds fell 7 percent when the Russians started their counterattack at Stalingrad in 1942, and French government bonds rose 16 percent after the Allied invasion at Normandy in 1944. Many such examples of the prescience of financial markets have been documented by economic historians.

Of course a few cherry picked examples, while suggestive, should not be considered conclusive.

Chris Masse, in a post about negative comments on the war by a just-retired high ranking military officer, said:

We can’t rely on retirees to tell us the truth. We need an anonymous information aggregation mechanism that gives an incentive to people who come forward with advanced information: the prediction markets.

While bond markets might be useful as a stand in for prediction markets, presumably well-designed prediction markets could provide a somewhat more articulated position than can be extracted from a twenty-year bond market.

NOTE: Greenstone’s paper, “Is the ‘Surge Working? Some New Facts,” is available from the SSRN.

In “Is The ‘Surge’ Working? Some New Facts“, MIT’s Michael Greenstone writes:

This paper shows how data from world financial markets can be used to shed light on the central question of whether the Surge has increased or diminished the prospect of today’s Iraq surviving into the future. In particular, I examine the price of Iraqi state bonds, which the Iraqi government is currently servicing, on world financial markets. After the Surge, there is a sharp decline in the price of those bonds, relative to alternative bonds. The decline signaled a 40% increase in the market’s expectation that Iraq will default. This finding suggests that to date the Surge is failing to pave the way toward a stable Iraq and may in fact be undermining it.

(HT to Alex Tabarrok at Marginal Revolution.)

Larry Downing / Reuters

—

George W. Bush is an imbécile. Who created ex nihilo this Iraq mess?

—

George W. Bush to be impeached by House of Representatives before end of his term in office

—

Static chart:

—

Iraqi Government to meet Oil Distribution benchmark on/before 30 Sep 07

—

Static chart:

—

National Leader Departure Markets: Iran, Iraq, Pakistan, Zimbabwe & Ireland

Friday, Jul 20, 2007
The Exchange has listed a number of contracts on the departure of various national leaders from their current positions. These can be found under Current Events — National Leaders.
We have contracts listed on:
* Mahmoud Ahmadinejad (Iran)
* Pervez Musharraf (Pakistan)
* Robert Mugabe (Zimbabwe)
* Bertie Ahern (Republic of Ireland)
* Nouri al-Maliki (Iraq)
A contract will settle (expire) at 100 ($10.00) if the named individual departs from their current position, as noted in contract description, before 11:59:59pm ET on the date specified in the contract.
The contract will settle (expire) at 0 ($0.00) if the named individual remains their current position at this time.
A departure includes (but is not limited to):
* Resignation
* Retirement
* Removal by electoral process (i.e. voted out of power in an election)
* Removal by coup d’etat
* Removal by constitutional process (e.g. impeachment)
These contracts do not cover the death of the person named in the contract. In the event of the named person’s death before the expiry date of the contract the contract will be unwound, all trades reversed and all trading fees refunded
A resignation or retirement does not have to result in the actual departure by the contract expiry date but rather the announcement of the resignation or retirement must be made and not rejected by that time/date.
A tendered resignation that is not accepted will cause the contract to expire at 0
A departure may be ‘forced’ or ‘voluntary’.
Expiry will be based on official, public announcements as reported and verified in three independent and reliable media sources.
Due to the nature of this contract please also see Contract Rule 1.9 Unforeseen Circumstances.
The Exchange reserves the right to invoke Contract Rule 1.8 (Time Protection) if deemed appropriate.
Any changes to the result after the contract has expired will not be taken into account – Exchange Rule 1.4
Please contact the exchange by emailing help@intrade.com if you have any questions regarding this contract before you place a trade.

Iraqi Government Benchmark – Oil Distribution

Friday, Jul 20, 2007
The Exchange has opened a contract on the Iraqi government passing the legislation required to meet their Oil distribution benchmark. This contract can be found under Current Events — Iraq — Benchmarks for Iraqi Government.
This contract will settle (expire) at 100 ($10.00) if the Iraqi government passes the legislation required to meet the following benchmark (distribution of oil resources and revenues) before 11:59:59pm ET on the date specified in the contract:
Benchmark: Enacting and implementing legislation to ensure the equitable distribution of hydrocarbon resources of the people of Iraq without regard to the sect or ethnicity of recipients, and enacting and implementing legislation to ensure that the energy resources of Iraq benefit Sunni Arabs, Shia Arabs, Kurds, and other Iraqi citizens in an equitable manner.
The contract will settle (expire) at 0 ($0.00) if the required legislation is not passed by this time
Note: The “implementation” of the legislation is not required for contract expiry. Once it has been passed into law the contract will be expired.
Expiry will be based on official and public announcements and as reported in three independent and reliable media sources.
Due to the nature of this contract please also see Contract Rule 1.9 Unforeseen Circumstances.
The Exchange reserves the right to invoke Contract Rule 1.8 (Time Protection) if deemed appropriate.
Any changes to the result after the contract has expired will not be taken into account – Exchange Rule 1.4
Please contact the exchange by emailing help@intrade.com if you have any questions regarding this contract before you place a trade.

Let’s hope that these contracts are stated correctly and that we don’t see any disputes between the traders and InTrade, at expiry time.