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Author: Coy, Peter

THE POKER FACE OF WALL STREET
By Aaron Brown
Wiley -- 350pp -- $27.95

In their marketing, financial firms go to great lengths to distinguish investing from gambling. But Aaron Brown, an executive director in risk management at Morgan Stanley, argues persuasively in his gleefully subversive The Poker Face of Wall Street that the distinction is false. This poker-playing iconoclast says finance would be a poor, tepid, and ineffectual thing without the vitality imparted by the gambling instinct. Traders play a minor role in economics textbooks, but Brown sees their risk-taking -- essentially, gambling -- as the engine of capitalism. "With good traders," he writes, "you can form and allocate capital without a building or regulations or centralized information." Without good traders, financial institutions "are no more efficient than government-run programs."

Brown knows whereof he speaks. He is a respected Wall Street risk manager and former trader with degrees in applied math from Harvard University and finance from the University of Chicago. He writes a column for Wilmott, a leading quantitative finance journal. He began playing poker at age 7 ("for edible stakes") and has bluffed everyone from Bill Gates and author Scott Turow to Nobel prize-winning economists and tournament pros.

The Poker Face of Wall Street is a sprawling, idiosyncratic, and sometimes poker-obsessed book filled with nuggets about American history and finance, from poker in gold-mining camps to the deeds of picaresque Scottish adventurer John Law, who used card games to grease the wheels of commerce in France's Louisiana Territory. The book's thesis is that the gambling impulse is not only inextinguishable but positively good for the economy. In poker's 19th century heyday, says Brown, the game served as a means of what economists call "capital formation" for frontiersmen who were cut off from the banks back East. Winners in long-running games would emerge with a stake big enough to do something useful, like build a bridge, while those who lost were forced to get off their butts and make more money.

The gambling urge also powered the agricultural futures exchanges. A rich futures trader might build a grain elevator or rail line to influence commodity prices and boost the profitability of a market bet. This, he says, is how the West was really won. "This system is brutal and unfair, ruthless and irrational, but it works with matchless efficiency," writes Brown. "To a financially trained poker player, it's the most beautiful organization in history. This -- rather than anything that happened in New York or Washington -- is the source of the American economic miracle."

Long hours at the poker table have given Brown a unique, not to say jaded, perspective on the hallowed institutions of modern finance. Accepted economic theory, for example, says that life insurance exists to minimize the financial risk of premature death. But Brown argues that a life insurance policy is more like a lottery ticket that beneficiaries buy in hopes of a windfall. Otherwise, he says, how do you explain why life insurance policies are bought by the middle-aged instead of by the young, whose families most need the protection? Likewise, he argues that the stock market is organized for gamblers. If not, asks Brown, why would the markets be set up for massive minute-by-minute trading when the same economic function could be accomplished by a once-a-day matching of buy and sell orders? Or take the Federal Reserve, which he irreverently compares to a card dealer who is being watched like a hawk by players in a casino. "The fanatic secrecy and delicacy associated with Fed decisions remind me more of gamblers ensuring a fair shuffle than scientists reaching open consensus about how to tune a precision machine," he writes.

Brown's arguments aren't always easy to follow, partly because the author strives for a breezy style even when dealing with complex material. For instance, it took me a while to grasp the mathematical link between bookmaking on a Yankees-Braves World Series and the pricing of stock options. Also, there's a ton of poker advice. He devotes six pages to a single hand of five-card draw. But it's all forgivable. After all, it's Brown's quirkiness that makes this book special.

Economists, who generally admonish people to avoid incalculable risks, may not like The Poker Face of Wall Street. Brown says "their fundamental theory is wrong." The real world, he says, is brimming with incalculable risks. He prefers mathematician Fischer Black's vision of the world as bunches of options -- i.e., opportunities. "If you win, great. If you lose, pick up the next option. That's gambling," Brown concludes, "and it's not a problem." In poker terms: Fold often, raise often, bluff on weak hands. Play loose.

The McGraw-Hill Companies, Copyright 2006

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By Peter Coy