Double or Nothing: How Wall Street is Destroying Itself

Tyler Durden's picture

Submitted by John Azis of Azizonomics

Double or Nothing: How Wall Street is Destroying Itself

There’s nothing controversial about the claim— reported on by Slate, Bloomberg and Harvard Magazine — that in the last 20 years Wall Street has moved away from an investment-led model, to a gambling-led model.

This was exemplified by the failure of LTCM which blew up unsuccessfully making huge interest rate bets for tiny profits, or “picking up nickels in front of a streamroller”, and by Jon Corzine’s MF Global doing practically the same thing with European debt (while at the same time stealing from clients).

As Nassim Taleb described in The Black Swan these kinds of trades — betting large amounts for small frequent profits — is extremely fragile because eventually (and probably sooner in the real world than in a model) losses will happen (and of course if you are betting big, losses will be big). If you are running your business on the basis of leverage, this is especially dangerous, because facing a margin call or a downgrade you may be left in a fire sale to raise collateral.

This fragile business model is in fact descended from the Martingale roulette betting system. Martingale is the perfect example of the failure of theory, because in theory, Martingale is a system of guaranteed profit, which I think is probably what makes these kinds of practices so attractive to the arbitrageurs of Wall Street (and of course Wall Street often selects for this by recruiting and promoting the most wild-eyed and risk-hungry). Martingale works by betting, and then doubling your bet until you win. This — in theory, and given enough capital — delivers a profit of your initial stake every time. Historically, the problem has been that bettors run out of capital eventually, simply because they don’t have an infinite stock (of course, thanks to Ben Bernanke, that is no longer a problem). The key feature of this system— and the attribute which many institutions have copied — is that it delivers frequent small-to-moderate profits, and occasional huge losses (when the bettor runs out of money).

The key difference between modern business models, and the traditional roulette betting system is that today the focus is on betting multiple times on a single outcome. By this method (and given enough capital) it is in theory possible to win whichever way an event goes. If things are going your way, it is possible to insure your position by betting against your initial bet, and so produce a position that profits no matter what the eventual outcome. If things are not going your way, it is possible to throw larger and larger chunks of capital into a position or counter-position again and again and again —mirroring the Martingale strategy — to try to compensate for earlier bets that have gone awry (this, of course, is so often the downfall of rogue traders like Nick Leeson and Kweku Adoboli).

This brings up a key issue: there is a second problem with the Martingale strategy in the real world beyond the obvious problem of running out of capital. You can have all the capital in the world (and thanks to the Fed, the TBTF banks now have a printing-press backstop) but if you do not have a counter-party to take your bets  (and as your bets and counter-bets get bigger and bigger it by definition becomes harder and harder to find suitable counter-parties) then you are Corzined, and you will be left sitting on top of a very large load of pain (sound familiar, Bruno Iksil?)

The obvious real world example takes us back to the casino table — if you are trying to execute a Martingale strategy starting at $100, and have lost 10 times in a row, your 11th bet would have to be for $204,800 to win back your initial stake of $100. That might well exceed the casino table limits — in other words you have lost your counter-party, and are left facing a loss far huger than any expected gains.

Similarly (as Jamie Dimon and Bruno Iksil have now learned to their discredit) if you have built up a whale-sized market-dominating gross position of bets and counter-bets on the CDX IG9 index (or any such market) which turns heavily negative, it is exceedingly difficult to find a counter-party to continue increasing your bets against, and your Martingale game will probably be over, and you will be forced to face up to the (now exceedingly huge) loss. (And this recklessness, is what Dimon refers to as “hedging portfolio risk“?)

The really sickening thing is that I know that these kinds of activities are going on far more than is widely recognised; every time a Wall Street bank announces a perfect trading quarter it sets off an alarm bell ringing in my head, because it means that the arbitrageurs are chasing losses and picking up nickels in front of streamrollers again, and emboldened by confidence will eventually will get crushed under the wheel, and our hyper-connected hyper-leveraged system will be thrown into shock once again by downgrades, margin calls and fire sales.

The obvious conclusion is that if the loss-chasing Martingale traders cannot resist blowing up even with the zero-interest rate policy and an unfettered fiat liquidity backstop, then perhaps this system is fundamentally weak. Alas, no. I think that the conclusion that the clueless schmucks at the Fed have reached is that poor Wall Street needs not only a lender-of-last-resort, but a counter-party-of-last-resort. If you broke your trading book doubling or quadrupling down on horseshit and are sitting on top of a colossal mark-to-market loss, why not have the Fed step in and take it off your hands at a price floor in exchange for newly “printed” digital currency? That’s what the 2008 bailouts did.

Only one problem: eventually, this approach will destroy the currency. Would you want your wealth stored in dollars that Bernanke can just duplicate and pony up to the latest TBTF Martingale catastrophe artist? I thought not: that’s one reason why Eurasian creditor nations are all quickly and purposefully going about ditching the dollar for bilateral trade.

The bottom line for Wall Street is that either the bailouts will stop and anyone practising this crazy behaviour will end up bust — ending the moral hazard of adrenaline junkie coke-and-hookers traders and 21-year-old PhD-wielding quants playing the Martingale game risk free thanks to the Fed — or the Fed will destroy the currency. I don’t know how long that will take, but the fact that the dollar is effectively no longer the global reserve currency says everything I need to know about where we are going.

The bigger point here is whatever happened to banking as banking, instead of banking as a game of roulette? You know, where investment banks make the majority of their profits and spend the majority of their efforts lending to people who need to the money to create products and make ideas reality?

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
LetThemEatRand's picture

Greenspan famously admitted that he underestimated the greed of the guys at the top.  Give them enough rope and they will always hang themselves.  Human nature.  Especially when they get to keep the profit and the taxpayer gets to keep the losses.

Aziz's picture

Humans have always been greedy. Greed has not always been underwritten by taxpayers.

AlaricBalth's picture

And ravenous greed, coupled with illegal or unethical behavior, used to have consequences. The fear of ramifications such as prison or bankruptcy used to be enough to keep most unfettered greed in check. Now, without these fears, avarice is unbound.

macholatte's picture



Give them enough rope and they will always hang you.

LowProfile's picture


I always save at least three bullets for myself (in case of misfires).

kiwidor's picture

that extra eye should give you 50% better aim....

Chartist's picture

This is why public hangins need to make a return....You think China would put up with this?  Risk the economy for a bigger bonus in China probably gets you a bullet to the head.

Jim B's picture

Most recent example.... Corzine, What a joke!


The man steals billions with NO consequences and regular folks are arrested for stealing a $1 soda!


Every President through modern history has spent money like their hair was on fire. No exceptions. And, Congress approved an endless litany of unbalanced deficit spending budgets year after year. They didn't mind creating slavery for the tax payer, and printing free money compliments of the Fed for their banker / Wall Street buddies to bail them out of the mess created by the miracles of deregulation. lobbying, and corruption.
All accomplished regardless of which party or President was in charge. They are all cut from the same block of cheese, and they are all culpable.  I just hope we survive the end result of having criminals running the country for decades. Put your money in something tangible, because the dollar is going to continue to tank, resulting in way more inflation. And, banks may not survive the firestorm of margin lending, credit default swaps, and derivatives created that exceed 250 quadrillion dollars in total  - more money than the gross domestic product of the entire planet for decades.  

The Federal Reserve is neither Federal nor a "Reserve". This private bank run by the "Bank of England" has been stripping the US of its assets since the days of Andrew Jackson.  If the $16,000,000,000,000.00 given away secretly, since 2007, to the member banks isn't reason enough to overhaul our entire government financial system then our country is doomed to financial failure.
You won't read this in the mainstream media....but it may emerge in the coming elections. Read about the first ever audit of the Fed and understand why we are in such trouble. 


emersonreturn's picture

"...but it may emerge in the coming elections."


perhaps...i've often speculated that one essential which separates western thinking from our eastern counterparts is our ability to believe wholeheartedly in the impossible.  we are icarus and don quixote.  dreams are our life's mitochondria.  i believe it's been one of our civilization's greatest gift, encouraging us to plunge headlong into a problem that by convential reasoning has been designated impossible and foolish, and to invent, discover or solve the puzzle or one of history's long out standing problems.  we naturally believe in santa claus, the easter bunny and that she was a virigin.  this allows us to aspire and reach for solutions beyond the rational and known.  hope, in our world, isn't an illusion or the sole remaining shelter for the hopeless and bereft but our intrinsic essential.



TWSceptic's picture

Greed is not the problem, it is merely a factor of life which can drive people to do good and bad things. But you did touch on the real problem: a mixed economy where government is responsible for bad behavior in the private sector. The solution: get government completely out of the economy.

LetThemEatRand's picture

I touched upon the "real problem" which is both a corrupt government and those who do the corrupting.  Your proposed solution addresses one of those concerns but not the other.   Think about organized crime.  Organized crime exists outside of government, and survives and indeed thrives even with substantial police and other law enforcement task forces charged with taking it down.  It corrupts who it can, and it terrorizes or kills those it can't.  It is in the business of making money and accumulating wealth, the ultimate goal of the "free market," yet the mob abhors a free market.  You arrest or kill one mobster, another takes over.   Take government away and the mob takes over completely by force.  No free market.  Keep some elements of government such as police and courts, and they bribe the police and judges or kill the ones who stand in their way.  Then where are you left?  Your solution is to let the strongest and most brutal rule us all with no check or balance whatsoever.  I realize that is not what you want, but it is what you'd get.

GeneMarchbanks's picture

'Take government away and the mob takes over completely by force.  No free market.'

Non sequitur. Your first sentence is the very essence of a 'free market' so how you can follow it up with the second blows my mind.

When any behavior is acceptable by society at large, the most forceful mob simply takes rule over the rest until it's displaced by another more ruthless one ad infinitum. This is the 'natural' state of affairs as Darwin identified by way of the 'natural' world and Marx in the human realm of resource distribution today known as economics.

The libertarian hallucination of preference is that they've discovered the source of all problems in government which needs to be kept 'small' since it is the root of all that plagues us.

James_Cole's picture

Don't forget socialism, the other boogeyman for simpletons - worker owned and operated is the devil's handiwork! So inevitably crony capitalism (corporatism) and socialism have become one and the same in American minds.

Incidentally, great article, far too many friends are victims of this dangerous investing strategy. I think some people get addicted to it, because when it's working it is wonderful, not so great when it crashes.

LetThemEatRand's picture

These are the same guys who drive down the interstate highway navigating with their GPS on their way to the airport to visit the Grand Canyon while they discuss how "government has never created anything.  It just steals."

GMadScientist's picture

The goobers created the Grand Canyon?!


StychoKiller's picture

You're assuming that airports, highways and GPS can only be brought into existence via Govt; check yer premises.

I seem to recall that the Wright Bros. perfected the airplane, NOT Govt;  Alexander Bell INVENTED the telephone, NOT Govt; James Watt developed the Steam Engine, NOT Govt; see where this is going?  (BTW, Govt DID invent ways to tax all these modern inventions!)

LowProfile's picture

Let's not forget that radio was developed by Marconi (not gov't again), and the chemical rockets that put those radio (GPS) satellite in orbit was invented by Goddard, (again, not gov't)...

The list goes on...

James_Cole's picture

"I seem to recall that the Wright Bros. perfected the airplane, NOT Govt;  Alexander Bell INVENTED the telephone, NOT Govt; James Watt developed the Steam Engine, NOT Govt; see where this is going?"

Funny argument StychoKiller, it proves another non-government discovery - 'two things are infinite: the universe and human stupidity; and I'm not sure about the universe.'


Anyway, personally I am an anarchist so I could care less about the government, but do wish the arguments on ZH weren't of the kindergarten variety.  


Psyman's picture

You are living in post-constitutional fascist America.  The very notion that such a ground breaking invention as the aeroplane can be invented/perfected by amateurs in 21st century America is laughable.  The fascist state would sooner murder the Wright brothers and give their invention to Boeing than allow such grass roots industry.


You need to accept that America is a fascist military empire.  Until you do that your analyses will be severely flawed.

Umh's picture

The roads are full of holes, the GPS satellites need to be replaced and the government is focusing most of it's efforts on the things it should not do at all.

LetThemEatRand's picture

The other common hallucination is that they would wind up on top of the heap.  

StychoKiller's picture

Your hallucination is that Libertarians WANT to rule!  Check yer premises.

LowProfile's picture

Don't confuse him with the facts, it distracts him from flogging straw men (to work out his authoritarian daddy issues).

HurricaneSeason's picture

Libertarians need to give up their own government careers BEFORE they get their libertarian card.

Al Gorerhythm's picture

You all seem to miss the cruxof the problem and that is; the enabler of all this, FIAT currency. Even the author gets lost in the maze:

"The bigger point here is whatever happened to banking as banking, instead of banking as a game of roulette? You know, where investment banks make the majority of their profits and spend the majority of their efforts lending to people who need to the money to create products and make ideas reality?"

The bigger point is; What ever happened to creating wealth first and then using is as a basis for lending, rather than creating interest bearing debt first and then paying more for the creation of the same wealth?

Ledger entry money creation by banks is not lending money, it is the provision of debt. Banks are not in the business of lending their own or anyone else's money, they are in the business of extending debt.

The problem then arises; how do you extinguish the debt completely without putting the bankers out of business? You don't. It has to be by force or decree. They are not going to let go of that gravy train without a fight. Just ask Charlie Munger.

Aziz's picture

Yeah, I agree with you. The bottom line is we had faster growth, more stable banks and less income inequality during the gold exchange standard period than afterward. Use those facts (Bank of England study) the next time a hapless Keynesian cites Eichengreen and Sachs. 

The unvarying value of gold is cold hard fact. The eventual death of all fiat currencies is another. We will get there eventually.

robertocarlos's picture

And that's why you don't have to pay any loans back to the bank. You promised them your future labour, they gave you no consideration.

dugorama's picture

oh, and have no regulators /referees, courts, etc?  


Omen IV's picture

Ha !

the only thing Don Corleone was criticized for in his entire career by the other Dons was NOT SHARING "ALL" - the politicians and judges - the true foundation of neo-capitalism



AlaricBalth's picture

Since the inception of the Federal Reserve in 1913, the Dollar has lost over 98% of its value. I would have to say that their track record for destruction is well documented.

Al Gorerhythm's picture

Now who in the hell would junk a truthful observation? WTF? There are some weird and wonderfuls out there, eh? True believers. WTFU. (Wake The Fuck Up!) Dump and run trolls.

Debt-Is-Not-Money's picture


"Now who in the hell would junk a truthful observation?"

Two junks is how you tell that your comment(s) hit home! They never reveal themselves (no transparency there) just like banksters or their agents

Silver Bug's picture

The QE time bomb is just itching to explode.

RafterManFMJ's picture

You had me at 'Wall Street detroying itself"

derek_vineyard's picture

Why are banks even permitted to 'trade' anything?

Their function is to take in deposits, loan money at higher rate of interest than they pay depositors and profit from that difference. Banks are supposed to be secure place to store your cash.  How the fxxk were they ever allowed to gamble with their deposits? What idiots deposited at banks that were gambling, so it became mandatory that most all banks gamble?

Us humans complicate the simpliest tasks.  The hedgies eventually will take out the banks...what a clusterfxxk.

bunnyswanson's picture



Provisions of the Glass-Steagall Act were directed at these abuses: [Return to Top]


  1. Banks were investing their own assets in securities with consequent risk to commercial and savings deposits. The concern of Congress to block this evil is clearly stated in the report of the Senate Banking and Currency Committee on an immediate forerunner of the Glass-Steagall Act.
  2. Unsound loans were made in order to shore up the price of securities or the financial position of companies in which a bank had invested its own assets.
  3. A commercial bank's financial interest in the ownership, price, or distribution of securities inevitably tempted bank officials to press their banking customers into investing in securities which the bank itself was under pressure to sell because of its own pecuniary stake in the transaction.


A Summary of the Rationale Leading up to the Enactment of the Glass Steagall Act [Return to Top]

The original (and in some measure, continuing) reasons and arguments for legally separating commercial and investment banking include:

  • Risk of loses (safety and soundness). Banks that engaged in underwriting and holding corporate securities and municipal revenue bonds presented significant risk of loss to depositors and the federal government that had to come to their rescue; they also were more subject to failure with a resulting loss of public confidence in the banking system and greater risk of financial system collapse.
  • Conflicts of interest and other abuses. Banks that offer investment banking services and mutual funds were subject to conflicts of interest and other abuses, thereby resulting in harm to their customers, including borrowers, depositors, and correspondent banks.
  • Improper banking activity. Even if there were no actual abuses, securities-related activities are contrary to the way banking ought to be conducted.
  • Producer desired constraints on competition. Some securities brokers and underwriters and some bankers want to bar those banks that would offer securities and underwriting services from entering their markets.
  • The Federal 'safety net' should not be extended more than necessary. Federally provided deposit insurance and access to discount window borrowings at the Federal Reserve permit and even encourage banks to take greater risks than are socially optimal. Securities activities are risky and should not be permitted to banks that are protected with the federal 'safety net'.
  • Unfair competition. In any event, banks get subsidized federal deposit insurance which gives them access to 'cheap' deposit funds. Thus they have market power and can engage in cross-subsidization that gives them an unfair competitive advantage over non-bank competitors (e.g. Securities brokers and underwriters) were they permitted to offer investment banking services.
  • Concentration of power and less-than-competitive performance. Commercial banks' competitive advantages would result in their domination or takeover of securities brokerage and underwriting firms if they were permitted to offer investment banking services or hold corporate equities. The result would be an unacceptable concentration of power and less-than-competitive performance.
  • Universal v. Specialized Banking. If the Glass-Steagall Act were repealed, the U.S. Banking system would come to resemble the German universal system, which would be detrimental to bank clients and the economy.
Manthong's picture

“the fact that the dollar is effectively no longer the global reserve currency”

OK… how many instances of proof of that are there? I can think of one off the top.. the fact that India, China and Russia trade oil (and other stuff)  with Iran in gold or national currency.

In the global landscape it may not be much, but other than that?..

BooMushroom's picture

So three or four of the worlds top economies are working to abandon something, and have already taken significant, real steps in that direction, and that's not much?

Once others realize we destroyed 98% of the dollar in 98 years, and we'll probably destroy 98% of what's left in the next 98 years, and there is an alternative, they'll go, too.

earleflorida's picture

This is what, 'we the people' had gotten, when we let the "GOPster's" gain complete control of Congress the last two years of the Clinton Presidency. Having a Supreme court packed with friendly Wall Street & Oligarchy Corporate advocates! Sound familiar?

Note: 11/3/98 {Dem's didn't help?}__ 11/2/99 __ 12/21/00  **Pecora Commission and FDR's legacy wiped-out in two "Fucking Years"!

Ps. Obama was never qualified, period! But, whomever got the Dem's nod was going to win after the people's disgust with Bush #43. Today we've got two idiots to choose from and being an independent that voted for Obama [ashamed to admit], will never vote for him again. My only hope is that after the elections the congress is without a majority in either party. I'm hoping that Romney will at least give Ron Paul a seat in his cabinet. If Paul accepts and Romney comes around to Paul's ideologies?

Ps2. Larry Lindsey & Paul O'Neill would be excellent cabinet selections also.     jmo

dark pools of soros's picture

The President is THEIR salesman -  why do you think ANYONE in that position will change anything?? 

RockyRacoon's picture

You gotta understand that folks won't read past your first sentence if it conflicts with their world view.   Put the partisan comments at the bottom of your post.   I gave you a greenie because I read the whole thing.   Attention span deficit and all that comes into play when there are over 50 pages of comments to scan and evaluate.   Your negatives are due to your failure to construct a comment that pulls in the anti-partisan readers -- or those who have deluded themselves into thinking that politics doesn't matter.

Umh's picture

Most people put their main point in the first line or two. It does cut down on the amount of reading to be done. He'll probably not listen to you anyway. Besides when people get all that NLP stuff going it's best not read past their name.

MeelionDollerBogus's picture

Pardon me any misunderstanding but I gave a red arrow for partisan nonsense that ignores the veto power of the President, Clinton, who is a Democrat.

Sudden Debt's picture

And as long as there are people willing to buy back your crap.
Now it's more like computer 1 is selling to computer 2
Both programmed to make a profit...

chunga's picture

don't ask don't tell throw jamie dimon down the well.

xela2200's picture

Fundamentals always win over arrogance.