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  • Suppose someone offered you an investment opportunity that couldn't lose. No matter what happened in the real world, your nut would be secure and you would come out ahead. Even if thousands of investors in the same market lost everything, you would prosper.

    What would be not to like? Wouldn't you take that deal if you could? But, almost certainly, you can't. That's because when it comes to investing your money, you have something to lose. That's called "skin in the game."

    Well, if you are a player at an investment bank, a fund manager, or a stockbroker, you have been there and done that. When prices jitter, you profit, thanks to the guys in the back office staring at screens and clicking keys making bids to cause price swings, and then buying and selling accordingly.

    As in the Wild West, the fastest gun usually wins the showdown. When prices move, money is made and lost in millisecond bursts. The biggest constraint is the speed of light, which nobody can overcome. They try though, by jockeying to get the shortest fiber-optic cable between their trading boxes and the exchange's servers.

    Even if they can't cozy up to a market, they can always make one. Just lock some MBAs, geeks and quants in a room, keep sliding pizzas under the door, and in a few days a they will birth a new financial instrument, with no intrinsic value and quite removed from any tangible assets. Perhaps it's a bet against the value of a tranch of bonds that cobble up fragments of real estate mortgages or equity investments. Of course, that new baby will not be regulated or trade on an exchange having reporting requirements. To do that would impede innovation and economic growth.

    As the investment house markets its new baby to customers, it hedges it, borrowing shares of it to sell short once the baby's bottom fills with poop and the customers are left holding the diaper. One thing leads to another until it's one big stinking mess, except for the midwives, who are off in the Bahamas or Côte D'Azure sunning themselves.

    This, as you may recall, actually happened five years ago, and will happen again any day now. Shit like this went and is still going down because none of those wizards have skin in the game, the first rule of which is to never put your nut at risk; always play with other people's money.

    If there is never a downside, who would ever bother to act prudently or do the right thing by a customer? It is human nature to play games that one believes can't be lost. That's what all those smart people say to one another.

    Take another look at the chart, the value of the Dow Industrial Average between June 2003 and May 2013. It looks like happy days are here again, but how would you plot its shape the over the next few months? Everything's going to be great, right?

    So mind your pennies, mates, and do so soon. Make sure the bastards don't rip off your precious epidermis.


    @image: Recent DJIA data from the Saint Louis Federal Reserve Bank charted in Excel.
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