Gambling with Other People’s Money

There’s an old adage used to describe someone acting recklessly with the assets of another person. We’ve all heard it: gambling with another person’s money. Googling the term is now nearly impossible, since “Gambling with other people’s money” returns a slew of results, with more than 90% of them being in regards to the 2008 financial crisis and similar topics to follow.


Far removed from the concept of actually walking into a casino with your brother’s $300, anyone who has watched any financial news in the past decade can’t help but think of gambling with other people’s money as being connected to certain events.  The subprime mortgage crisis, the bailed out banks, or even the CEOs with golden parachutes making risky corporate gambles alongside even riskier hedge fund gambling come to mind


Regarding the risky practices of banks bailed out by taxpayer money, one US Senator really pushed this metaphor in her public condemnation: “Let’s embrace productive capitalism, not casino capitalism, by restoring transparency and true competition in the commodities markets. Our nation’s financial sector can act as a great force for job creation and production. We should not stand by and let their dimly lit casino bring us all down once again.” While this rhetoric may seem somewhat hyperbolic at a glance, new research into the neuroscience of incentives, gambling, and social pressures shows that literally gambling with another person’s money is an idea really not that far removed from the bad behavior of Wall Street tycoons acting on perverse incentives.


Frontiers in Psychology, a neuroscience journal, recently published an article well summarized by its headline: “Reputational concerns, not altruism, motivate restraint when gambling with other people’s money.”


If not for public condemnation and shame, there would be nothing to prevent this “gambler’s mentality” for those who experience privatized gains and socialized losses, and can have an expectation of this. This is not to criticize those who did everything in their power to prevent calamity in 2008 (something most economists, conservative and liberal agreed was a result of the bailouts and TARP as unpalatable as they were to the public). Yet in the immediate aftermath, when it was in the public’s interest to restrain those same gamblers who were now almost literally… gambling with other people’s money–yours and mine, it became a disingenuous piece of political rhetoric on the part of the gamblers that the very modest reform proposals such as gigantic bonuses, risky bets, and requiring more substantive collateral behind hedged investments, were somehow meddling in the free market. When in reality, all such regulations would do is reduce the glaring moral hazard of perverse incentives, something sure to affect the behavior of individuals. This is where micro and macroeconomics collide.


As confirmed by a similar Stanford study, when one is given the opportunity to gamble with another person’s money, perception of optimal incentives can become very skewed.


The Las Vegas Journal reports an incident in which three businessmen carried out a tax fraud scheme by gambling with other people’s money. Their scheme involved an Internet package that promoted tax deductions by saying that clients could get as much as  $10,475 under the Americans with Disabilities Act. This program was marketed across the nation affecting thousands of people. The three guys responsible for this scheme were caught and ordered to serve three years of supervised release following their prison terms, furthermore they had to pay back more than $35 million in restitution to the people affected by the scheme. Gambling with other people’s money might be easier, but this instance proves that it definitely comes with higher stakes.


To take it one step further, the buying and selling of death benefits can be said to be a form of gambling involving one’s life and death. This type of “gambling” was first seen in the 1980’s when certain investors began to buy the life insurance policy of people who had AIDS. People who wanted to reap the death benefits of an individual sought these viatical settlements. Thus, people with illnesses such as AIDS who had a short time to live were the primary targets; buyers would pay these people a portion of their death benefits and then sell the interest from those benefits to interested investors. The price of shares depended on how long the infected person had to live. Broken down into a more digestible scenario, host of the podcast EconTalk and George Mason University Contributor Russell Roberts explains the root of the metaphor, and how it applies:


“Imagine a superb poker player who asks you for a loan to finance his nightly poker playing. For every $100 he gambles, he’s willing to put up $3 of his own money. He wants you to lend him the rest. You will not get a stake in his winning. Instead, he’ll give you a fixed rate of interest on your $97 loan.


The poker player likes this situation for two reasons. First, it minimizes his downside risk. He can only lose $3. Second, borrowing has a great effect on his investment—it gets leveraged. If his $100 bet ends up yielding $103, he has made a lot more than 3 percent—in fact, he has doubled his money. His $3 investment is now worth $6.

But why would you, the lender, play this game? It’s a pretty risky game for you. Suppose your friend starts out with a stake of $10,000 for the night, putting up $300 himself and borrowing $9,700 from you. If he loses anything more than 3 percent on the night, he can’t make good on your loan.


Not to worry—your friend is an extremely skilled and prudent poker player who knows when to hold ‘em and when to fold ‘em. He may lose a hand or two because poker is a game of chance, but by the end of the night, he’s always ahead. He always makes good on his debts to you. He has never had a losing evening. As a creditor of the poker player, this is all you care about. As long as he can make good on his debt, you’re fine. You care only about one thing—that he stays solvent so that he can repay his loan and you get your money back.


But the gambler cares about two things. Sure, he too wants to stay solvent. Insolvency wipes out his investment, which is always unpleasant—it’s bad for his reputation and hurts his chances of being able to use leverage in the future. But the gambler doesn’t just care about avoiding the downside. He also cares about the upside. As the lender, you don’t share in the upside; no matter how much money the gambler makes on his bets, you just get your promised amount of interest.”


While this example from Roberts is definitely more illustrative of the concept, one need not even get quite so scholarly to see this example in action. One Tripadvisor forum in a Vegas thread began with what seemed an innocent enough question; would you give the full amount if you won placing a bet for someone while visiting Vegas? The discussion quickly devolved into many people revealing that even when gambling with other people’s money, simply put, anonymity fosters greed.