A correspondent asks me whether short selling would pose a problem for Middle East Peace Bonds - an application of the Social Policy Bond idea aimed at eliminating violent political conflict in that part of the world: "If bonds are freely tradable, then presumably a terrorist organization might choose to short these bonds, thereby profiting from the much more easily and cheaply achieved goal of causing destruction to the peace process."
The gist of my reply is that, first, the comparison should be with the current system, rather than a Utopian ideal. MidEast Peace Bonds (MEPBs) I think would improve on the current possibilities, but they will not be perfect. Under the current system terrorists could profit by short-selling of share indices before they commit an outrage. If they short-sold MEPBs, the probability of their being traced would be greater than under the current system, simply because there would be fewer traders of the bonds than share indices. Efforts to track or deter such trading could be made simpler by the bonds being issued for large sums combined with some system of ownership registration, as with current financial instrument trading; they could be issued in denominations of $1 million or upwards, say.
By short-selling the bonds the terrorists would therefore risk exposure, as well as suffer the public opprobrium of appearing calculating and pursuing pecuniary benefit, which might not sit well with some of their supporters.
More generally, it is almost certain that the price of any particular Social Policy Bond would not always be rising monotonically from its float price to its redemption value. It would be justifiable, as well as efficient, if bondholders could hedge against consequent falls in the value of their assets. People who do not hold bonds might want to participate in markets for derivatives of bonds, some of which would rise in value as the targeted goal became more remote. This in turn means that speculators and short sellers could certainly profit from short-term bond price falls, and the question again arises as to whether these people would then take steps to impede progress towards any targeted goal.
There are two main reasons why they would probably not. The first is that, in the long term, the weight of money would be against them. Provided sufficient funds were allocated to achieving the targeted objective, there would be a net positive sum of money payable if the targeted objective were to be achieved, and a net zero sum paid as long as the goal were not achieved. All the long-term incentive would be to achieve the targeted objective. Those who, for whatever reason, would suffer from achievement of the objective could be compensated by bondholders, or bribed to change their ideas. Note also that for every buyer of a 'put' option there would be a seller, and that for every futures contract bought on the expectation that the bond price would fall, there would be an equivalent futures contract sold on that basis, so that the net incentive generated by derivatives would be in line with the incentive created by the underlying financial instrument, the Social Policy Bond: in the long run, this would favour achievement of the targeted objective. The other reason that short sellers, or holders of 'put' options, in Social Policy Bonds might not take actions aimed at interfering with achievement of the goal is that such actions might well already be illegal or, again given the incentives that the bonds would generate, be made illegal - or have their provenance more enthusiastically investigated - once the bonds had been issued. Some miscreants might be tempted to sell bonds targeting water pollution short (or buy 'put' options) then dump a million tons of manure into Chesapeake Bay. But they would know that such an act is illegal - and that there will be people at the other end of their transactions who will be highly motivated to see the law enforced to its fullest extent.
The last two paragraphs, above, are based on an excerpt from my book on Social Policy Bonds, completed recently and available here, in electronic or hard copy.
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