Inherent gamblers

Investment banks are dead.

Or are they? Investment banks may have shut shop, sold their pants to someone, or let someone else share their trousers but is the American habit of ‘investment banking’ dead? That habit of gambling on the markets, creating money out of thin air, packing and re-packing BBB rated bonds in a magical way such that they come out the other side as AAA bonds?

I don’t think that art is dead. In fact it can’t die. It is somehow ingrained in the genes of the Americans because their economy was never a savings economy. It’s always been consumerist. And that is why you can take out the investment banks but you can’t take out the investment baking from an American.

There is a wonderful book called “A World of Chance” written by Canadian economists Reuven and Brenner. Amazon.com introduces the book with this statement:

Although financial markets often try to distance themselves from gambling, the two factors have far more in common than usually thought. When, historically, there were no financial institutions such as banks, lotteries constituted the ways by which expensive items were disposed of, and governments raised money quickly. Gambling tables fulfilled roles that venture capital and banking do today. 'Gamblers' created clearinghouses and sustained liquidity. When those gamblers bet on price distributions in futures markets, they were redefined as 'speculators'. Today they are called 'hedge fund managers' or 'bankers'. Though the names have changed, the actions undertaken have essentially stayed the same. This book shows how discussion on 'chance', 'risk', 'gambling', 'insurance', and 'speculation' illuminates where societies stood, where we are today, and where we may be heading.

So it wasn’t yesterday, or last week, or sometime in 2007 that investment banks were characterized (even chided) for being gamblers. Subprime didn’t pull their towel and make them naked. They were gamblers all along. It was gambling that created the insurance industry and the futures markets. Remember the first pork futures markets in Chicago where people gambled on pigs that eventually led to the creation of CBOT? Gambling has been part of American life all along right from wild, wild, west days where cowboys bet on poker and women to the present day $800billion bail out package.

Someone said, think of America as a town with one casino, in which the only economic activity is gambling. Most people lose, but the casino keeps lending them more money to play. Eventually, of course, the casino must go bankrupt. At this point, the townspeople people vote to tax themselves in order to bail out the casino. Collectively, the gamblers cannot help but lose because the odds of winning are never 50:50; individually they nonetheless hope to win their way out of this whole system and make it big in life. After all it is the land of opportunities. The frequency of the casino going bust varies but history shows it keeps happening once every decade – sometimes more severe and sometimes less so. And of course the gamblers go through a period of ‘depression’.

Why do Americans gamble so much? Again the book “A World of Chance” gives an interesting insight:

If people reach the age of fifty or fifty-five and have not "made it," what are their financial options to still live the good life? Except for allocating a few bucks to buy lottery tickets, it is hard to think of any other option. If people find themselves down on their luck and see no immediate opportunities to get rich, what can they do to sustain their hopes and dreams? Allocating a fraction of their portfolios with a chance to win a large prize is among the options. And when people are leapfrogged - that is, when some "Joneses" who were "below" them jump ahead - how can they catch up? They will tend to challenge their luck for a while, taking risks that they might have contemplated before in business, financial markets, and other areas but did not follow up with action.

But that wouldn’t happen in India. Because we have been (and that is rapidly changing) a savings economy. People abhorred the concept of having debt on their personal balance sheets. Our savings attitude prevents us from gambling. We behave like the ants and Americans like the grasshoppers. But unlike the grasshopper that dies, there is always a casino that bails them out. And the casino is funded by rest of the world and grasshoppers themselves.

Have a look at the following two charts. The first one shows the population pyramid of USA for the year 2000. There is an increasing bulge in age group 40+ who have not yet “made it” in their lives. The bulge will have actually shifted upwards if you were to look at a 2008 chart. With failing pension funds, increasing healthcare, high inflation and depressing mortgage industry, what hope do they have other than to gamble?

In the chart below, an astounding 70% of the American household earns less than USD 70,000 a year. Divide that by an average family of four you get USD 1500 per month per person. So when one fine day the neighbor “Jones” bucks the trend and makes it big it is not difficult to see why a combination of ageing population plus the sinking feeling of not having ‘made it’ big in life lures them to gambling (read investment banks and hedge funds).

Unfortunately for Americans they need to keep taxing themselves ($800 billion is just the start) to keep the casino functioning but in the long run it’s just another cycle in their long gambling history and this too will pass.