Thirteen years ago today, James G. Rickards received a phone call: “Jim, we just lost 500 million; you’d better get back to Greenwich.” Soon after, he would be called upon to broker a $3.6 billion bailout of the hedge fund Long Term Capital Management (LTCM). It was paid for by big banks and orchestrated by the NY Federal Reserve.

Rickards said, “What strikes me now, looking back, is how nothing was changed: no lessons were applied. Even though the lessons were obvious, in 1998. […] Regulatory oversight needed to be ramped up […] The government did just the opposite. Glass-Steagall was repealed in 1999, so that banks could become hedge funds. The U.S., in effect stared near-catastrophe in the eye, with LTCM, and decided to double down.”

One bias of our capitalist system is that we believe profit is the mark of a functioning system. As a result, regulation is seldom sought to control money-making enterprises. There is an implied message: If it ain’t broke, don’t fix it.

On the flip side, losses are frequently pinned on needless and overly aggressive regulation. No one ever wants to kick an industry while it’s down. As a result, squeaky losers generally get rewarded with deregulation.

Even when a regulatory weakness or failure leads to disaster — a la Enron, Madoff, LTCM, Lehman Brothers, and Full Tilt Poker — anti-regulatory bias, fueled by industry lobbying coffers, eventually trumps temporary populist outrage and public risk.      

I’m no Ron Paul. But I’m not a member of the U.S. Federal Reserve’s fan club either. While it may have helped the financial system from collapsing in 2008, the Fed was instrumental in removing key foundation blocks that had held it in place since the Depression.

One of the Fed’s primary tasks is to regulate the banks. But as is often the case, the regulators forged a cozy bond with the regulated — and the Fed became one of the early and powerful champions of bank deregulation.

When early attempts by Congress to weaken the Glass-Steagall Act failed, the Federal Reserve unilaterally “reinterpreted” the section of the law that had restricted commercial banks from dealing in securities. Starting in the mid-1980s, the Fed voted to allow bank holding companies to derive up to five percent of their revenues from trading in a narrow range of securities. By the mid-1990s, following a series of “reinterpretations,” the Fed allowed 45 percent of bank revenues to come from dealing in a wide range of securities.

The proposed merger of Citi Bank and Travelers in 1998 — and $300 million of bank lobby money — finally enticed Congress to pass the Graham-Leach-Bliley Act in 1999, codifying the Federal Reserve’s wishes and the banking industry’s wet dream.

With a clean license to deal, the primary growth engine for banks became securitization — or the repackaging of debt, like mortgages. Fostered by both loose and unenforced  regulation, the securitization market ballooned to roughly $10 trillion in the US by 2008.

I liked online poker. But I was never a fan of an unregulated or self-regulated poker industry. For one thing, its infancy was marked by a notable regulatory disaster. When the fledgling online company PokerSpot run by Dutch Boyd suffered financial difficulties, it raided players’ accounts in an attempt to stay afloat. It eventually wiped out every deposit on its journey into the abyss.     

PokerSpot’s early failure was written off as a rogue fraud — but it was a regulatory harbinger.

In the early 2000s, new online poker companies blossomed and thrived. They made so much money a few of them even launched successful IPOs. With billions on the line, the new companies aligned themselves with agencies that promised regulatory cover.

Alderney, the third largest of the Channel Islands, played host to one of these regulatory bodies. In “licensing” Full Tilt Poker (FTP), the Alderney Gambling Control Commission scored a big fish. Since FTP was so profitable and big, Alderney allowed it some regulatory slack. Instead of requiring the company to segregate or “ring fence” player accounts, it allowed the company to co-mingle player accounts with the company’s business accounts.

In December 2010, it was widely known (as F-Train documents here) that the Department of Justice was investigating online poker’s payment processors. Even then, neither FTP nor Alderney did anything to insure the safety of player funds. On April 15, 2011 (Black Friday) FTP’s business accounts were seized by the Department of Justice. FTP stated it was unable to reimburse players’ money due to the seizure. Even today, it is unknown whether there are adequate funds to cover the player accounts and there are rumors of a $60 million shortfall. 

On June 29, Alderney suspended Full Tilt’s gaming licenses, well after the horses had left the barn.     

Michele Davis: “And what do I say when they ask me why it wasn’t regulated?”
Hank Paulson: “No one wanted to; they were making too much money.”
– From the 2011 HBO movie “Too Big to Fail”

I’ve seen some bashing of the Poker Players Alliance (PPA) in the wake of DOJ indictments involving three online poker sites. I’m not a particular fan of the PPA. But I dislike lobbying organizations in general.

If online poker sites were engaged in bank fraud as alleged, I’m not sure how the PPA is to blame. Maybe my expectations of the lobbying group are different than the expectations of its members. But that difference could be costly for the PPA in the near future.

The PPA purports to be a grass roots organization defending players’ rights. In reality, it is an organization fostering an agenda consistent with businesses who want to operate in a lucrative, regulated, US online poker market.   Read More »