Poker, The Stock Market, And the Greatest Con of All Time

I figured out the stock market. It’s all one big theater play. One big con. In order to explain, I’d like to go on a wide tangent about the game of No Limit Texas Hold ‘Em. It’s relevant. I promise. Believe me? Mmmm excellent.

No Limit Texas Hold ‘Em

The rules of poker are deceptively simple. Each player gets two cards face down that only they can peek at. Each player gets a chance to bet. Each successive player can either raise, call (which means match the bet) or fold. Then the dealer lays out three cards face up on the table for everyone to see and there is another round of betting. One more face up card and a round of betting. Then the fifth and final card placed face up and the final round of betting. 

The secret of poker is that it’s not about what cards you have, it’s how you play them. Imagine having two Jacks and your opponent goes all in (bets everything). Do you call? Are you that bold?  Wouldn’t you feel dumb when it turns out they have a pair of Queens? And so, as the old adage goes, “It’s better to fold and appear stupid, than to go all in and remove all doubt.”

On the other hand, if you expect your opponent to have a Two and a Three, if you see through your opponent’s ruse, you can “call their bluff.” The problem with folding is that it tells your opponent that you’re willing to fold! It means they can get away with bigger and bigger lies. If they never get called out, if you fold every time, they win.

The Stock Market

I’m reading a book called, “The History of the United States in Five Stock Market Crashes” by Scott Nations. The first crash in 1907 was partly caused by a man, Fritz Heinze, who bought enough stock in a bank to have the controlling vote, made himself president, and then loaned himself money to buy more stock in more banks. Banks, he reckoned, were based on trust. As long as there was trust in banks, he could write himself checks and cash them too. (This was common practice back then. I’m not blaming Fritz in particular. He just makes a good example.) 

Banks make money by making smart loans and collecting interest. Banks can only hold as many deposits as people trust the banks to make smart loans. A smart loan is when the risk is small relative to the interest gained, and diversified. For the same reason you don’t put all of your eggs in one basket, you don’t make one giant loan to one person, who works in the same industry as yours. This was not a smart loan because if anything happened to one bank, or one person, the bank would lose all of their money. Although as long as no one called him out on making such a stupid loan, he could continue to write himself loans. He was running a confidence game and hoping no one would call him on his bluff. 

The brothers, Otto, Aurthur, and Fritz Heinze conspired to manipulate the market (which was legal and common practice too.) Fritz owned United Copper which had a stock on the New York Stock Exchange that they would target. The plan was simple; Otto would borrow money from Fritz to execute numerous buy orders, and simultaneously borrow money to order a few “short” sales. A short is when you expect the price to go down, you borrow stocks and then sell them at a lower price. The motivation behind this scheme is that the flurry of activity would inspire other traders to get in while the going is good and raise the price of the stock.

Unfortunately it all backfired spectacularly. The price didn’t move up as expected. It moved down. Otto had more buy orders than short orders. Which meant that Otto now owed more money that he started with. And when the other traders saw that the price was going down, they all sold too. The price went from $70 down to $10 in a matter of weeks. Which meant Fritz was bankrupt too. And all of his customers at his bank thought, “Why is this bankrupt man running my bank? I better take my money out of the bank just to be safe.” All of his customers thought this and all of them took their money out. 

It might have made front page news and been the end of it… except he wasn’t the only one, nor the biggest bluffer. There were many other men just like Fritz. What brought the stock market to its knees is that not only could you not trust Fritz, but you couldn’t trust his brothers, his associates, vendors, and ultimately people lost trust in both the financial industry and the stock market as a whole. It was as if five people were playing poker, and they all went all-in without even a pair of twos. 

We have since put regulations on banks to prevent daisy chain ownership like Fritz did. Unfortunately, the stock market remains largely unchanged. Certainly there are some aspects of a business that can be broken down to fundamentals: assets, liabilities, management, IP etc. But in large part, it’s still based on borrowed money, bluster, and notoriety. Can any sane person explain to me why Tesla’s stock is $736 and GM is $50 (almost 15x more)? 

The Greatest Con of All Time

The only advice I can faithfully give, from drawing parallels between poker and the stock market, is that it really doesn’t matter what the fundamentals of business are, because there will always be con men who are playing to win, instead of playing to create. At the end of the day, we just have to be aware, and cautious around risky ideas and the people who go “all in” on them. Going all in on a poker hand is often a sign of a weak hand and an overconfident player. But, what are we going to do about it? Shorting the market in today’s terms would look like going all in on gold bullion. Even if shorting the market is the rational course of action, how long would you be willing to hold onto gold while your friends are looking at 10% returns on their stock portfolio? 10 years? And if you’re wrong? You go bust. Sometimes it’s safer just to fold.