Illustration by Whitney Sherman
Eighteen months ago I opened a tax-protected mutual fund for my daughter’s future college tuition. I was betting that this “moderately aggressive fund” would grow more quickly than the same money invested in a savings account, a CD, or gold bullion. The fund grew 15 percent in six months and then promptly took a nose dive. The account is currently worth less than it was when I opened it. Nevertheless, I have not withdrawn my investment. Not only would I have to pay taxes, but the gambler in me fully expects his luck to change.
We all take risks, and we all engage in trading (betting) on future prospects. Generally speaking, though, we think of banks and other financial institutions as safe places to put our money—after all, the word “trust” appears in so many of their names, and bankers have a reputation for being conservative, if not downright stingy. Recently, however, we’ve been learning that, as financial institutions seek ever-higher rates of return for their stakeholders, they engage in increasingly risky ventures: subprime mortgages to individuals with poor credit ratings, hedge funds, speculation in commodity futures. When these ventures fail, U.S. citizens pay the price, whether through a multibillion dollar bailout package or the collapse of these same institutions.
There are obvious parallels between business and gambling—parallels that the entertainment industry has delighted in exploiting. Take the recent movie 21, which depicts gambling in terms borrowed from finance. Based on the History Channel documentary Breaking Vegas and the book Bringing Down the House, it tells the story of a group of MIT students who devised a blackjack card-counting scheme calculated to increase their odds of winning. The film takes great liberties with the book, and the mathematical theory on which the scheme was ostensibly built does not hold up under scrutiny. However, there was indeed a group of students who won as much as $4 million playing blackjack. Where did this group get its financial backing? The student leaders—J.P. Masser, John Chang, and Bill Kaplan—provided their own venture capital, incorporating in 1992 as a limited partnership called Strategic Investments. One of the participating students, Jeff Ma, told Wired magazine, “The first year I played, we returned 154 percent to our investors. That’s after paying off expenses. You try to do that on Wall Street.”
Indeed, the parallels to the 1987 film Wall Street are too delicious to pass up. The young stockbroker Bud Fox (played by Charlie Sheen) experiences the same adrenalin rush from closing a major deal that gamblers get from winning a large pot. He wants to be like his mentor, Gordon Gecko (Michael Douglas), a takeover artist and multibillionaire with a “greed is good” credo. To put Gecko’s action into gambling terminology: He plays a high-stakes game; by trading on inside information, he can predict how the cards will fall; and he runs his competition out of the game by bidding at a level they can’t match. He makes off with huge earnings, destroying companies and social capital in the process. (Gecko’s credo is, of course, a perversion of Adam Smith’s emphasis on self-interest. According to Smith’s “invisible hand” theory, the free market will operate smoothly and we will all benefit if we each pursue our own self-interest. But Smith was a moral philosopher before he was an economist, and he was concerned that managers look out for their stakeholders’ interests, not just their own. His “private agency problem” recognized that managers are less likely to take good care of other people’s money than they are of their own—the rationale behind today’s boards of directors.)
Hollywood aside, does the gambling metaphor hold up in real life? How about in commodities trading? Energy traders interviewed in the documentary Enron: The Smartest Guys in the Room report feeling euphoria, an adrenalin rush, and blood lust from reaping windfall profits for their company and huge commissions for themselves—all while California was suffering rolling blackouts and astronomical energy prices, in large part due to Enron’s actions.
And in hedge funds? Take the recent case of so-called “rogue trader” Brian Hunter. Under his direction, Amaranth Energy Advisors LLC purchased a huge number of natural gas futures, holding more than 50 percent of all such shares available in January 2007. Hunter was betting that the price of natural gas would rise in the winter of 2006/2007 and that Amaranth would make a huge profit. He devised a strategy to go “long” with natural gas that would be delivered that winter, while “shorting natural gas that would be delivered in the fall of 2006,” according to a CNNMoney.com article. Instead, his gamble fell short, and Amaranth lost more than $6 billion, by some estimates. Amaranth subsequently went bankrupt. Recently, one Amaranth investor filed civil and class action suits against Hunter, who is also being charged by the Federal Energy Regulatory Commission and Commodity Futures Trading Commission with having caused larger-than-usual fluctuations in the cost of natural gas by manipulating the market.
I would argue that the relationship between gambling and investing is more than a metaphorical one, that their parallels are more than superficial. The adrenalin rush of winning at blackjack or in business can be addictive and can lead to irresponsible behavior that disrupts not only the risk-taker’s life but the lives of many around him. Just as the gambling addict may ignore the needs of his or her family, spending its savings and going into debt—partly for the thrill of playing the game and partly in the desperate hope that his luck will change—so a commodities trader or hedge fund manager may ignore the risks of investing in securities that are less than secure and the disastrous consequences that his actions may have for his stakeholders. Once embarked on a risky course, he may lack the will or strength of character to disengage.
On a systems level, both games of chance and the free market depend on a kind of controlled randomness in which no individual has an unfair advantage. The free market ceases to apply to corporations that are so large that, by their actions, they can change that market. Someone who figures out how to control a market—whether through insider trading or by cornering a commodity such as natural gas—is cheating the system just as the gambler who counts cards or plays with a stacked deck is doing so. In either case, the cheater disrupts the random element built into games of chance, generally forcing both the house and other gamblers out of the game.
