Friday, June 25, 2010

The Proliferation of Poker and the Beginning of the Financial Crisis

Yes it's true. I know it's a bit out there. You think it's just another crazy pup theory. How can a little Poker hurt the entire world's economy? Well, I'm glad you're here for me to explain it to you.

Poker was first seen on the television as an annual sideshow. The World Series of Poker. Through movies and various marketing, the existence of this event was popularized outside of the world of professional gamblers. The event grew as ESPN began showing the event on their network and attacting a great deal of new followers. Marketing it like a sports event with announcers, creating poker 'superstars', story lines within the game among players and with the invention of the table cam (that little camera that shows what cards the players have), Poker official became a spectator sport.

In order to legitimize the game, the announcers talked of theory and the math behind the game which is all true. There are indeed a lot of theories and math behind playing this game. Pretty basic human behavior 101 stuff, but nevertheless, legit discussions on what the poker players were thinking and how they were behaving. What these announcers knowingly or unknowingly were doing, was steering people away from the fact that at the end of the day, poker is still a gambling game. The very definition of winning or losing in gambling is that a lot of it is based on chance. Not due to any specific formula or theory. No one wins in a casino because they were smarter than the casino. You were merely more lucky than the casino for that period of time you were there. Given more time, the house will always win.

Most of us have seen someone make the most ridiculous bet in a casino and for it to come up a winner or something playing completely against 'the book' in blackjacks and yet they win. Was that person smart for making that bet? Did that person calculate their chances and decide that it was a good idea to bet? No, more than likely, they were impulsive or drunk or probably both. Putting down a bet that had very little chance of winning. Yet they do and they won. They were not smart. They were lucky.

By focusing on the 'skills' of these Poker players, the announcers avoid the other I would say 80% part of the game of Poker. That which is luck. Watching it on TV, it always shows a player's chance of winning. A player could do everything 'by the book' and they will still lose. In a real game based on skill, if you do everything perfectly, there is a very little chance that you would lose.

For example, if poker was indeed a skills game, you would see the same people in the final table in all the tournaments like in other skills games, but you don't. In most major tournaments, there are always several amateurs. This would not happen in a game that was based more on skill then luck. It would be a miracle for an amateur to appear in the finals of the Wimbledon or say the World Cup. In poker, however, that would be a norm.

So the idea here is that with proliferation of poker, we are blurring the line between gambling and statistics in the world. People believed by relying solely on statistics, they could predict the outcome of something even though in reality, there is still a great deal based on luck. This is the mentality that has driven the world into the financial crisis.

Traditionally, Wall Street looks at the fundamentals of a stock to determine if it is a good idea to invest in the company. They took the time to investigate the company’s books, their strategy, and their customers. They did this in person, and they did this by getting to know the people that ran the companies. With the advancement of technology and statistics, this practice began to slow as investment firm began running statistical models on companies and basing their evaluation on that information. No longer is it a matter of knowing what a company did, how they did it, and who they have doing it. It’s now just plugging in a range of key numbers and statistics and plugging it into a math model.

I’m not against the statistic models. I think they’re important and very useful. I’m not commenting on Wall Street’s practices either. What I am concerned with, is the people at Wall Street and their shift in mindset. It seems that they feel safe with these statistic models and in turn that has made them more bold in making risks. As now, with statistic models, all counts as calculated risks hence it’s ok. You could always blame the model if your investments goes bad. As we saw with the financial crisis, these statistic models created these derivatives that started the downwards spiral, and greed grew this problem to crippling the world.

I’m not saying that there aren’t lots and lots of other reasons for the crisis as well, but I believe this mentality is the root cause of a lot of the other issues. When you believe you can predict the future simply by complex statistical equations, and then add to that the greed that is inherent on Wall Street, this is exactly the result of the outcome.