An Economist Asks: Who Made Money On 9/11?

It's September 21. Exactly ten years ago today, an investigation began at the SEC, FBI, and other agencies into trades made by the architects of the 9/11 to profit financially from those attacks. Ten years later, the SEC and partner law enforcement agencies have uncovered no publicly-available evidence, made no arrests, and recovered no profits. Many economists, including myself, believe many millions (or even billions) of dollars were made by those with knowledge of the 9/11 attacks only a short distance from Ground Zero - on Wall Street.

The trail has long been cold, lost in the ether of millions of trade executions per day on the world's major exchanges. The trades the SEC was looking for are sitting somewhere, snowflakes on a mountain of other put options on UAL, AMR, the S&P, and the DAX. The gold bought at less than $200 per ounce before 9/11 has since been sold for huge profits (as I write this, gold is up about 900% from pre-9/11 levels). Or, maybe the terrorists' sponsors used half a dozen of the other hundreds of possible trading strategies to make a fortune from 9/11. This post is less about the SEC's incompetence as a law enforcement agency (enough has been written on that in the wake of the Madoff scandal) and more about the problem of when people bring non-public information about future terrorist attacks into public markets.

There are two rules that cause big incentive problems in this area and cause people to commit acts of terrorism:

1) It's easier to make a big bad thing happen than a big good thing.
2) It's easier to profit from a big bad thing than a big good thing.

And modern markets give people ways to profit from these bad activities just as easily as - and in many cases more easily than - good activities.

If it's so easy to cause a big disruption and profit from it, why don't more people do disruptive things and profit from the fallout? Some behavioural economics experts I've spoken to suggest the "wiki effect" is part of the answer. The "wiki effect" is an allusion to Wikipedia and similar websites that allow visitors to edit content. Many had theorised such sites would fail: Internet vandals would constantly post irrelevant information or delete things and there would be no economic incentive to fix the vandalised web pages. But, this didn't happen. Wikipedia and its many sibling sites continue, largely unmolested, and generally provide accurate information.

It is hard to make a profit by vandalising Wikipedia. Meanwhile, there are huge incentives for people like the architects of 9/11 to commit terrorist attacks because it is so easy to profit from them. The terrorist not only easily makes back any money spent on the attack, but also makes a large profit of millions with a low risk of prosecution. By comparison, the economic incentives for police officers attempting to prevent terrorist attacks are low: the wages for an entire career represent only a fraction of what successful terrorists might earn in a single trade.

Why, then, do we have such poor policing of terrorist trading activities? It's a side-effect of what I call "street-level optimisation." Law enforcement agencies are optimised around handling street-level crime. If a suspect's car is stopped with $500 of cocaine on the passenger seat, or a $500 handgun on the passenger seat, police officer will know what to do. Yet, if a suspect's car is stopped with a laptop on the passenger seat containing information on Madoff's fifty-billion-dollar fraud, it's likely that person will simply be issued a speeding ticket and sent on his way. Why? It's partly because police officers are good with drugs and guns, but tend to be less-than-proficient at spreadsheets and finance.

Law enforcement agencies simply don't attract the people with the skillset and knowledge needed to detect the activities of sophisticated organisations. Modern-day terrorists don't make their money from protection rackets, street-corner drugs dealing, and overseas remittances; they are funded by a complex mixture of activities far from the street-level. To extract maximum financial benefit from international terrorist attacks requires an advanced knowledge of finance, trading, and economic modeling. The logical method for enforcement agencies would look at two areas: financial and human capital.

To build a complex scheme to profit from international terrorism requires two things... money and know-how.

Major terrorist organisations don't just play with their own money - they likely have investors. And many of these investors probably have no idea they're investing in a terrorist attack. If someone you trust told you there was a surefire opportunity to make 10% in a month and gave you a convincing story, how many questions would you ask? Would you know if a terrorist group made 30% with your money and only gave you a third of the profits? Finding this pattern, capital raised on unusual terms on short notice before major events, would seem a key detection methodology.

The other component is human capital. These organisations need much more than an introductory course in finance - they need world-class banking and legal experts to structure their investments. The supply of this talent is substantial, but nonetheless finite. Keeping track of unusual career paths or career choices among top talent would be an interesting database related to the SEC's broader mission, as well as a dataset relevant to tracking major terrorist activity.

Follow the money, follow the talent.

That's what I'd do if I were the SEC, FBI, and other agencies looking into this problem.

I don't know if my methodology would yield better results than the U.S. government's strategy (which failed to find a single trader) during the last ten years. But I'm certain the results couldn't be any worse.