The other day I re-watched one of my favorite movies, one that I hadn’t seen in a long time. I was thinking about the markets and metals at the time, and the combination caused me to come to an unforeseen conclusion: Pretty much everything you need to know about investing in the 21st century is contained in the poker movie Rounders.
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If you haven’t seen it, Rounders revolves around the underground world of poker players in New York City, and the plotline is pretty simple- a talented former player who has tried to move on to a more “upstanding” profession (he is attending law school) unwisely vouches for a childhood friend who runs up a huge poker tab that is ultimately owed to Russian mobsters. To save himself and his friend, the player is drawn back into the world of underground poker and has three days to work his way through various games to try and come up with the money.
The real insights come about the observations of the game itself. The writers spent two years getting to know the world of poker from the inside, interviewing and spending time with everyone from world-class poker players, to the “rounders” who make their living playing in the small-stakes games portrayed in the movie, to the casual games they played in all over the country from firehouses to VFW halls. The core insight they gleaned is that poker is not “gambling” in the sense that everyone has the same chance to win (as statistically they should) but that poker is instead wholly a skill game, a brutal contest of strategy, will, and game theory where the casual players, given enough time at the table, would lose to the pros virtually every single time. Indeed, though people steeped in the “investors” mindset would probably recoil at the comparison, poker is extremely similar to trading in that chance, dealing with the unforeseen, calculating risk and return on every hand and pot, and most crucially playing against the other players (or market participants) are all shared characteristics of the two contests. Professional traders would have a great deal in common with professional poker players.
The running commentary of “Mike D” (played by Matt Damon) provides the central narrative of the lessons, or insights into this world and how it works, during the film. The writers wanted to distill some of the more powerful lessons they learned, and some of these quotes came straight out of the mouths of the professional players they interviewed during their research.
Rounders starts with one of the best opening movie quotes of all time, and it sets up the entire premise:
“Listen, here's the thing. If you can't spot the sucker in your first half hour at the table, then you are the sucker.”
Wall Street has gone through various cycles of mass-participation by the public in stock investing, and public fervor for stocks has waxed and waned through the years. The famous “shoe-shine boy recommending a stock as the harbinger of the 1929 crash” represents one peak of this public participation, and in the aftermath of that crash stocks were viewed as too dangerous for most people for a generation. The “go-go market” of the mid 60’s was another peak, and the decline that followed discouraged yet another generation of people, but the cycle always returns. In each and every case, the public IS the sucker at the table, but advertising and sales pitches have employed more and more sophisticated strategies and have effectively convince them that this is not the case. Greed always overwhelms fear eventually.
As a result, we see strange contradictions in ordinary people’s attitudes towards investing. On the one hand, they will say “I don’t play in the stock market” and claim “trading is dangerous” because Wall Street is too slick, too powerful, and has too great an informational advantage and will beat the small-time trader every time. On the other hand, they have no problem buying in to 401k’s or retirement accounts based primarily on stocks. In their minds, those things are merely “prudent investing” and not “trading”. For some reason, people hear the words “buy and hold” and “diversified asset allocation”, sold to them by uncounted television ads by the very same Wall Street firms they claim to distrust, and they have no problem gambling at the exact same casino because it has been sold to them as a responsible and prudent thing to do.
These people don't seem to realize that when they sign-up for that 401k through their employer or have their union bargain for additions to a pension fund invested primarily in stocks, they are unwittingly sitting down at the table to compete against the exact same players in the exact same arena as if they were personally trading stocks, despite their protestations otherwise. These people would do well to look around at the entire financial system and ask themselves “who is the sucker at this table”. I am pretty sure it isn’t JPM or Morgan Stanley. For generations now, the investing public has been the sucker at the table, they just haven’t known it.
When the investing public plays (knowingly or unknowingly) at the Wall Street casino, they do so in the context of a carefully crafted fairy-tale that goes something like this: “Freely traded markets will go up and down, but the prosperity they create will raise all boats over time so if I just buy and hold, I will grow my wealth eventually. In the short-term, however, there will always be winners and losers and this is just how the game is played- everybody places their bets and takes their chances”. The fiction is that everyone at the table has a clean shot at winning. They don’t.
"Why do you think the same five guys make it to the final table of the World Series of Poker EVERY YEAR? What, are they the luckiest guys in Las Vegas?"
Every trade is a zero-sum game, and for every winner somebody has to have taken the other side of that trade. There are equal numbers of winning and losing trades, but these trades are by no means evenly distributed within the market. Think about these headlines:
Now most people think of all those high-powered firms and traders and would think “Well yeah, they are pretty cutthroat, but the fierce competition between those folks is what makes a market”. Does it really?
In one scene the two protagonists make a run down to Atlantic City where they unexpectedly run into a half-dozen other Rounders from New York sitting at a public poker table at the casino. They all know each other and while they are exchanging greetings and insults, two regular guys at the hotel for a convention sit down at the table. With their cheap suits and nametags, they might as well have targets painted on their chests. As the pros exchange knowing smiles, the narrator tells us that these poor schmucks have no idea what they just stepped into.
“We're not playing together. But then again, we're not playing against each other either. It's like the Nature channel: You don't see piranhas eating each other, do you?”
The two conventioneers think they know how to play because they sit in on a Thursday night game back home. They have no idea that, through the ruse of an “even-odds game”, they are going to be harvested by the sharks at the table no matter what cards they draw. And all of the pros at the table are holding to another hard and fast rule:
“It's immoral to let a sucker keep his money”
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It will be interesting to see what happens when the current big-stakes game of financial liars poker is done. We have pyramids of market bets by the big financial players, topped by even larger pyramids of derivatives bets. All of the players at the table are the risk counterparties to all of the other players at the table, and the understanding among them is that if they all lose- if the markets they are harvesting so aggressively get away from them entirely - the US taxpayer (via the Federal Reserve) will make all of them whole again if anything goes wrong. They have every reason to believe this will be the case, because it has always been so. From Long Term Capital Management to the Bear / Lehman / AIG fiasco of 2008, the US taxpayer has always made them whole when things go wrong. But is this an endlessly viable option?
It seems to me that the financial system and their partners the Federal Reserve are backed into a corner. If the Fed allows interest rates to rise, the interest on the 17 trillion dollar national debt (against just 3.5 trillion per year in tax revenues and a trillion-plus yearly deficit) would begin to accelerate, compounding upon itself as the debt is rolled over and could quickly undermine what remaining confidence there is in the US dollar. To keep interest rates low in the face of a market that doesn’t want to buy any more US debt, the Fed has become the buyer of last resort and has now taken 4 trillion dollars on its balance sheet already. If they keep taking on more, their own credibility will be undermined. Damned if they do, and damned if they don’t.
And backstopping the whole thing is the American taxpayer, the people whose productivity and labor ultimately have been pledged as collateral for the entire financial circus. The problem is that these people are knee-deep in debt, they are watching their purchasing power evaporate thanks to the Fed. They‘re just hanging on by their fingernails and praying that their paltry 401k bet will come through. The situation they are in, if this can be believed, is even worse than the Fed. They will have zero tolerance politically for yet another bailout of the Wall Street gamblers who treat them like marks then demand their money to be made whole when the schemes go belly-up. The public has been squeezed dry to the point that there is simply nothing left.
"I've often seen these people, these squares at the table, short stack and long odds against them. All their outs gone. One last card in the deck that can help them. I used to wonder how they could let themselves get into such bad shape, and how the hell they thought they could turn it around."
At what point will these people look around the table, realize they have been suckered in the most egregious fashion, and simply get up and walk away? After all, the game can only go on as long as they are still willing to ante-up. The day is coming when the public will either push away from the table or they will be out of chips. Either way, it’s game over.