Derivatives and the World Series

As a former financial writer as well as a former sportswriter, I ask you: What do Wall Street and the World Series have in common? And the answer: Both require widespread suspension of disbelief in order to function effectively. And both collapsed this fall.

John Maynard Keynes once observed that the stock market is like a newspaper beauty contest in which readers must pick not the prettiest faces but the faces that other readers are likely to consider prettiest. The Yale economist Robert Shiller took that analogy a step further: Readers must actually deduce “the faces that most people think that other people think that other people think would be the prettiest. That kind of thing kind of unravels, and it produces nonsense.”

The rise of derivatives— that is, financial instruments derived from other financial instruments— has further compounded the nonsense. Mortgage-backed securities, for example, arose from the best of intentions: By repackaging a mortgage loan as a security and dicing it into small bits, the risk of lending money could be spread so widely that no lender would feel the pain of an individual default, and consequently home loans would be easier to obtain.

This ingenious system worked wonderfully until it collapsed this year. Only with the recent crash of the housing market (and the subsequent crash of all other financial markets) has it occurred to us that pain and risk are good things: If no lender fears getting hurt in any transaction, no one will take the responsibility to make sure that borrowers are credit-worthy.

Hitting and catching balls

Baseball operates somewhat the same way. There is no intrinsic value in the ability of nine men to run around a field throwing, hitting and catching baseballs— unless huge numbers of people persuade themselves that such an activity is important. That’s why the integrity of the context (in baseball or any organized sport) is so critical. If you tamper with it too much, the whole structure falls apart for lack of meaning.

Such a moment occurred— for me at least— on Monday night, October 27, when the Phillies and the Tampa Bay Rays attempted to play the fifth game of the World Series in pouring rain and 39-degree weather. Until that night I had eagerly anticipated the Phillies’ second World Series victory in their 125-year history. But as I watched drenched players wearing earmuffs slosh about in mud puddles and chase wind-blown pop flies halfway across the infield, the whole thing lost its logic. Who could celebrate a victory in such a game?

“Game 5 is hopelessly tainted by what transpired between the time the game should have been called and the middle of the sixth inning, when it was finally suspended,” wrote Phil Sheridan in the Inquirer. True enough— but Game 4 on Saturday night was tainted too. That contest was delayed 91 minutes by rain; it didn’t start until after 10 p.m. and didn’t end until 1:47 a.m. The field was dry by then, but what’s the point of asking the world’s best baseball players when it’s way past their bedtimes?

A summer game in late October

Sheridan raised the right question— why play an autumn game at night, when it’s so much nicer and warmer in the afternoon?— but he didn’t go far enough. The critical question is: Why is a summer game like baseball still being played at all at the very end of October?

The answer, of course, is the invention, a generation ago, of post-season playoffs— first one round, and now two rounds— which not only extend the season but also render the regular season largely meaningless. And that raises yet another question that nobody (especially in Philadelphia) dares to ask: Did the two teams playing in this year’s World Series really deserve to be there?

In the world of my youth, Major League Baseball consisted of two leagues of eight teams each. Each team played an equal number of games against every other team in its league. When the regular season ended, the winners of the two leagues played each other in the World Series. Simple, fair, and comprehensible even to small children. (To be sure, it was sometimes boring, too, especially when the Yankees habitually clinched the American League pennant around Labor Day.)

The Cubs and the Angels

Today the end of the season is much more exciting but also much more pointless. Each league consists of 15 teams broken into three divisions. Each team plays barely more games against the teams in its own division than the teams in the other two divisions. Each team also plays a random assortment of games against teams in the other league. Despite this inequity, all games are counted equally. At season’s end, the “winners” of all three divisions enter the playoffs, along with a fourth “wild-card” team that didn’t win any division.

In other words, the team that compiled the best record all season long— this year the Chicago Cubs in the National League and the Los Angeles Angels in the American— won’t necessarily play in the World Series. Suffer a few injuries or lapses at playoff time and your whole season is wiped out.

To put it another way: Major League Baseball today isn’t really baseball; it’s a derivative of baseball. No one really understands how it works. And as sages as diverse as Warren Buffett and the late Robert Montgomery Scott have observed, if you don't understand it, don't do it.

After Monday night’s Game 5 was suspended, the Inquirer’s Todd Zolecki wrote: “A 28-year wait to celebrate will have to be a little longer.” Really? Why wait? Since the championship is only what fallible humans say it is, why not declare ourselves the winners and hold the celebration regardless? If the Cubs and Angels were smarter, they’d hold their own World Series and do likewise.


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