Tuesday, December 16, 2008

"Financial psychopaths wreak havoc."

I try to keep an open mind specifically in spite of my opinions. Capitalism works, but scandals like the Madoff one do test my so called "faith". Forbes went so far as to call Madoff a financial psychopath in response to his peculiarly candid admission of guilt. What if, I think, one quarter of all CEO’s turn out to be engaged in scandal? Then again, politicians aren't perfect either, and giving them more money only shifts and centralizes responsibility. But what if the average human, given high enough earnings, can’t help but let money get to his mind? This happened to me once at a casino. Allow, reader, for a personal anecdote followed by a return to larger issues at hand.

A friend and I once visited a casino pledging to each other that we would only bring $100, spend it on Blackjack using basic strategy, and double down after each loss. We’d spent a few weeks memorizing basic strategy, which is a set of established pre-determined decisions that minimize the house’s advantage to just over one percent. And then doubling-down on each loss means that you double your ante after each hand that you lose. So if you lose on a one-dollar hand, you bet two dollars; if you lose again, then four; eight, etc. Beginning with a minimum bet of $5, it only takes six consecutive losses before you find yourself betting $160. Then again, when or if you finally win, you regain your losses plus a hefty percent. Nonetheless, things add up quickly when you double-down. Although your odds are almost fifty-fifty with basic strategy, you can easily lose more than six times in a row if you play long enough. But that’s why went in with a pact. This way we wouldn’t chicken out. Worse case scenario, we leave after 30 minutes and cut our losses.

Funny thing, we started winning. At first it just felt like dumb-luck. Then it continued. The minimum bet was $5, but after breaking a few short strings of losses, your average winnings per hand becomes much more than $5 – assuming, of course, that you still have the money to double down with. Independently we each approached scary bets - $80, $160 - that threatened to be our last. But we reminded ourselves of our agreement, fortune smiled upon us, and we’d find ourselves with $320 dollars instead of zero. The pit-bosses were eying us with suspicion, and when we each had around $500 we had to take a break. We returned and the winnings kept adding up, until I had around $1000 and my friend had much more.

Eventually reality set in as forcefully as it had stepped out. As we started losing, we got nervous, we each veered away from the strategy, got burned by it, started again, and got burned some more. Degrading smiles replaced the pit-bosses’ suspicion. I left with $200, my friend left with none. When I tell the story friends often ask why I didn't just leave with $1000. I tell them that's precisely missing the point, because if I was thinking rationally, I wouldn't have been in there in the first place.

This 6-hour roller-coaster of an experience changed how I viewed the world. Sometime in the middle, I distinctly recall reaching a point where nothing made sense anymore. Here was this thing money - its intrinsic value I never thought of much - that you work so hard for, and all the sudden, it’s falling out of the sky. I was shaking, palms sweaty, simply trying to keep my growing number of chips in neat piles. You lose a nerve-racking $160 bet and think that was stupid, but then you’d gain twice that on the next one. In a very fundamental way, the walls of reality began to melt, as if I was on hallucinogenics.

Does a similar thing happen to CEO’s? The worry is that you begin making an incredible amount of money, then only attribute your gains to things you do, when it really might just be market-conditions or lady-luck dealing you a good hand. Of course, success isn't all due to luck, but it still plays a big factor. Contrary to our thoughts at the time, my friend and I hadn't found the secret to earning tons of money, we'd merely been dealt a few good hands. Nonetheless, you can find yourself feeling indestructible, beyond rationality and rules, when that's clearly not the case. This is essentially what happened to The Smartest Guys in the Room who raised and crashed Enron. It wouldn't be far off to call them megalomaniac gamblers. They openly embraced risk as a business strategy.

At the same time, it’s easy to overlook how the alternative – socialism, communism – contains at least the same risk of public scandal, if not more. Political scandals are arguably more frequent than financial ones. By keeping politics separate from too much capital, at least to the degree possible, we can isolate such incidents.

Financial scandals still contain a distinctly different feel than political ones. A political scandal may kill an individual’s career, but little fundamentally changes except for, perhaps, a few more people now see politics as dirty. Financial scandals, on the other hand, are weightier. They affect more people’s daily lives, as economics is fundamentally more powerful than politics. They also turn into liberal cannon-fodder for an end to free-market capitalism. But once again, I'm not sure how giving more money to politicians is any better.

It’s an irony of our government that we try to succeed in unnecessary undertakings while failing in very basic areas. When approved drugs turn out to be dangerous, the FDA (who already have an impossibly difficult job) gets more money; but when Wall Street steals money, the SEC receives little public scrutiny, and, at the most, legislates a few new rules. The Forbes article on Madoff does a good job in placing some blame on the SEC, who rightly received similar criticism after the Enron scandal. All too often, however, the SEC's response is new legislation and rules, not better policing or detective-work. New rules that only pave the way for people to look for new ways to break them. People go astray all the time. We need to catch them.

The experience at the casino taught me about the misery of the gambler, a play on a theme of the sort of people who drive down seemingly indestructible companies like Enron. Similar I'd imagine to breaking the law, when you first get away with gambling you feel lucky; when you do it again, you might feel empowered; and when you keep doing it, and keep raising the stakes, you feel indestructible...until, of course, your inevitable downfall. Of course there's a rational part of you that knows this is wrong, just as Madoff knew unquestionably that he was wrongfully breaking the law. When you disregard rationality, life’s aspirations are suddenly right next to its underbelly. It draws a thin line between heaven and hell, placing you short-term in the former, long-term in the latter. Left in its natural state and allowed to fend only for itself, gambling’s predominant outcome is complete utter failure. All the more reason to decentralize capital.

-KJ
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Media (in order of appearance):

Photo: (1) Bernard_L_Madoff, 12/15/2008, marclsudo; (2) compulsive, 04/01/2005, by fictures; (3) someone has to win., 09/23/2007, by austrini; (4) Morning gamblers at Whiskey Pete's, 04/01/2007, by CFBSr; (5) BALLY'S WALKWAY, 08/23/2005, by snowriderguy; (6) Extra, 05/25/2006, by Alex Steffler; (7) Dice, 09/28/2005, by RobW.
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