Sports Betting and Financial Derivatives

By Kennedy Maize

Washington, D.C., May 6, 2010 — Gambling appears to be a nearly ubiquitous human trait, as a news release I received recently demonstrates. The release, from Bookmaker.com, an offshore gambling den (online betting is technically illegal in the U.S., but that’s a joke) offers the odds that BP will be able to stop the Gulf of Mexico oil spill with its 100-ton, 40-foot-tall containment dome. Get your money down.

One can bet on whether the containment chamber will be 80 percent effective, under 80 percent effective, will stop the leak all together, or will make the leak worse. Sounds a lot like sports betting? You betcha, to borrow a phrase. The Cyprus-based bookie handles a lot of sports action, as well as offering poker, table games, and plenty of other types of action.

Bookmaker.com CEO Mickey Richardson, says the press release, presides over “one of the largest sports books in the world, and his team of experienced odds makers have put together lines for just about everything.” And you can wager using your Blackberry.

Americans – men, mostly – don’t have any trouble understanding the complications of sports betting, and the myriad of artificial things one can bet on: point spreads, over-under, touchdowns by quarter, free-throws taken, and the like; just about any thing the human mind can conjure where there are betters willing to take sides.

The bookies, as everyone knows, always win. When action gets too heavy on one side of a bet, the bookie will “lay off” by betting with another bookie, hedging the bet. This protects against big losses for the book. As Wickipedia puts it: “Their working methods are similar to that of an actuary, who does a similar balancing of financial outcomes of events for the assurance and insurance industries.”

The aim of the bookie is not to “win” the bets, but to make money from the transaction, no matter who wins. It’s a very lucrative business, which is why it flourishes regardless of legality. When I was a kid growing up in Pittsburgh, one of the local barbers, Ferdie, had a backroom book, completely illegal. He occasionally got busted, but that didn’t shut him down for long. He made a lot more money on the ponies than he did on giving kids flattops.

I’m not a gambler, but here’s a wager for you: how many nuclear plants will be generating power in the U.S. in 2017? The over-under is four, and I’m going under for $50 (and over for $10). See how it works?

While these concepts are pretty clear, folks who almost instinctively understand them claim not to understand what has been happening on Wall Street for more than a decade. Sports bets, and the bets on BP’s success in stopping the blowout, are “derivatives.” Their value is derived from something else that is tangible: A ball game, a horse race, a manmade disaster, and so forth.

Once upon a time, Wall Street’s job was to guide investors into placing their money in ways that would yield returns commensurate with the risk. No more. Now Wall Street is Vegas in pin stripes. Bankers have become bookies, middle-men that facilitate bettors (and occasionally lay off bets, as Goldman apparently did in it’s latest troubles).

Those guys – and yes, they are mostly guys – in the $3,000 suits, Hermes ties, and Larry King-style braces, are hoovering up money on both sides of bets (sub-prime mortgages will flourish, sub-prime mortgages will tank) and occasionally place their own bets, laying off the risk.

The financial gurus create their own jargon – synthetic collateralized debt obligations, interest-rate swaps, currency swaps, butterfly straddles, credit default swaps and the like. That’s all designed to mystify what they do and have done. They don’t want us to know how fundamentally simple it really is.

But to demystify it, just think: “I’ve got the horse right here, his name is Paul Revere.”