Against the Gods: The Remarkable Story of Risk (4 page)

-hy is the mastery of risk such a uniquely modern concept?
Why did humanity wait the many thousands of years leading up to the Renaissance before breaking down the barriers that stood in the way of measuring and controlling risk?

These questions defy easy answers. But we begin with a clue. Since
the beginning of recorded history, gambling-the very essence of risktaking-has been a popular pastime and often an addiction. It was a
game of chance that inspired Pascal and Fermat's revolutionary breakthrough into the laws of probability, not some profound question about
the nature of capitalism or visions of the future. Yet until that moment,
throughout history, people had wagered and played games without
using any system of odds that determines winnings and losings today.
The act of risk-taking floated free, untrammeled by the theory of risk
management.

Human beings have always been infatuated with gambling because
it puts us head-to-head against the fates, with no holds barred. We
enter this daunting battle because we are convinced that we have a
powerful ally: Lady Luck will interpose herself between us and the fates (or the odds) to bring victory to our side. Adam Smith, a masterful student of human nature, defined the motivation: "The overweening conceit which the greater part of men have of their own abilities [and] their
absurd presumption in their own good fortune."' Although Smith was
keenly aware that the human propensity to take risk propelled economic
progress, he feared that society would suffer when that propensity ran
amuck. So he was careful to balance moral sentiments against the benefits of a free market. A hundred and sixty years later, another great
English economist, John Maynard Keynes, agreed: "When the capital
development of a country becomes the by-product of the activities of
a casino, the job is likely to be ill-done."2

Yet the world would be a dull place if people lacked conceit and confidence in their own good fortune. Keynes had to admit that "If human
nature felt no temptation to take a chance ... there might not be much
investment merely as a result of cold calculation."3 Nobody takes a risk in
the expectation that it will fail. When the Soviets tried to administer
uncertainty out of existence through government fiat and planning, they
choked off social and economic progress.

Gambling has held human beings in thrall for millennia. It has been
engaged in everywhere, from the dregs of society to the most respectable
circles.

Pontius Pilate's soldiers cast lots for Christ's robe as He suffered on
the cross. The Roman Emperor Marcus Aurelius was regularly accompanied by his personal croupier. The Earl of Sandwich invented the snack
that bears his name so that he could avoid leaving the gaming table in
order to eat. George Washington hosted games in his tent during the
American Revolution.' Gambling is synonymous with the Wild West.
And "Luck Be a Lady Tonight" is one of the most memorable numbers
in Guys and Dolls, a musical about a compulsive gambler and his floating
crap game.

The earliest-known form of gambling was a kind of dice game
played with what was known as an astragalus, or knuckle-bones This
early ancestor of today's dice was a squarish bone taken from the ankles
of sheep or deer, solid and without marrow, and so hard as to be virtually indestructible. Astragals have surfaced in archeological digs in many parts of the world. Egyptian tomb paintings picture games played with
astragali dating from 3500 Bc, and Greek vases show young men tossing the bones into a circle. Although Egypt punished compulsive gamblers by forcing them to hone stones for the pyramids, excavations
show that the pharaohs were not above using loaded dice in their own
games. Craps, an American invention, derives from various dice games
brought into Europe via the Crusades. Those games were generally
referred to as "hazard," from al zahr, the Arabic word for dice.6

Card games developed in Asia from ancient forms of fortunetelling, but they did not become popular in Europe until the invention
of printing. Cards originally were large and square, with no identifying
figures or pips in the corners. Court cards were printed with only one
head instead of double-headed, which meant that players often had to
identify them from the feet-turning the cards around would reveal a
holding of court cards. Square corners made cheating easy for players
who could turn down a tiny part of the corner to identify cards in the
deck later on. Double-headed court cards and cards with rounded corners came into use only in the nineteenth century.

Like craps, poker is an American variation on an older form-the
game is only about 150 years old. David Hayano has described poker
as "Secret ploys, monumental deceptions, calculated strategies, and
fervent beliefs [with] deep, invisible structures .... A game to experience rather than to observe." 7 According to Hayano, about forty million Americans play poker regularly, all confident of their ability to
outwit their opponents.

The most addictive forms of gambling seem to be the pure games
of chance played at the casinos that are now spreading like wildfire
through once staid American communities. An article in The New York
Times of September 25, 1995, datelined Davenport, Iowa, reports that
gambling is the fastest-growing industry in the United States, "a $40
billion business that draws more customers than baseball parks or movie
theaters."8 The Times cites a University of Illinois professor who estimates that state governments pay three dollars in costs to social agencies
and the criminal justice system for every dollar of revenue they take in
from the casinos-a calculus that Adam Smith might have predicted.

Iowa, for example, which did not even have a lottery until 1985,
had ten big casinos by 1995, plus a horse track and a dog track with 24hour slot machines. The article states that "nearly nine out of ten Iowans say they gamble," with 5.4% of them reporting that they have
a gambling problem, up from 1.7% five years earlier. This in a state
where a Catholic priest went to jail in the 1970s on charges of running
a bingo game. Al zahr in its purest form is apparently still with us.

0

Games of chance must be distinguished from games in which skill
makes a difference. The principles at work in roulette, dice, and slot
machines are identical, but they explain only part of what is involved
in poker, betting on the horses, and backgammon. With one group
of games the outcome is determined by fate; with the other group,
choice comes into play. The odds-the probability of winning-are all
you need to know for betting in a game of chance, but you need far
more information to predict who will win and who will lose when the
outcome depends on skill as well as luck. There are cardplayers and
racetrack bettors who are genuine professionals, but no one makes a
successful profession out of shooting craps.

Many observers consider the stock market itself little more than a
gambling casino. Is winning in the stock market the result of skill combined with luck, or is it just the result of a lucky gamble? We shall
return to this question in Chapter 12.

Losing streaks and winning streaks occur frequently in games of
chance, as they do in real life. Gamblers respond to these events in
asymmetric fashion: they appeal to the law of averages to bring losing
streaks to a speedy end. And they appeal to that same law of averages to
suspend itself so that winning streaks will go on and on. The law of averages hears neither appeal. The last sequence of throws of the dice conveys absolutely no information about what the next throw will bring.
Cards, coins, dice, and roulette wheels have no memory.

Gamblers may think they are betting on red or seven or four-of-akind, but in reality they are betting on the clock. The loser wants a short run
to look like a long run, so that the odds will prevail. The winner wants
a long run to look like a short run, so that the odds will be suspended.
Far away from the gaming tables, the managers of insurance companies
conduct their affairs in the same fashion. They set their premiums to
cover the losses they will sustain in the long run; but when earthquakes and fires and hurricanes all happen at about the same time, the short run
can be very painful. Unlike gamblers, insurance companies carry capital
and put aside reserves to tide them over during the inevitable sequences
of short runs of bad luck.

Time is the dominant factor in gambling. Risk and time are opposite sides of the same coin, for if there were no tomorrow there would
be no risk. Time transforms risk, and the nature of risk is shaped by the
time horizon: the future is the playing field.

Time matters most when decisions are irreversible. And yet many
irreversible decisions must be made on the basis of incomplete information. Irreversibility dominates decisions ranging all the way from
taking the subway instead of a taxi, to building an automobile factory
in Brazil, to changing jobs, to declaring war.

If we buy a stock today, we can always sell it tomorrow. But what
do we do after the croupier at the roulette table cries, "No more bets!"
or after a poker bet is doubled? There is no going back. Should we
refrain from acting in the hope that the passage of time will make luck
or the probabilities turn in our favor?

Hamlet complained that too much hesitation in the face of uncertain outcomes is bad because "the native hue of resolution is sicklied
o'er with the pale cast of thought ... and enterprises of great pith and
moment ... lose the name of action." Yet once we act, we forfeit the
option of waiting until new information comes along. As a result, notacting has value. The more uncertain the outcome, the greater may be
the value of procrastination. Hamlet had it wrong: he who hesitates is
halfway home.