Risking on gambling

The Economist magazine just did a Special Report on gaming and wagering:

You bet

Shuffle up and deal

The risk instinct

At war with luck

Bet on the bot

Log on, ante up

Lengthening odds

Cutting off the arms

When the chips are down

The dragon's gambling den

Come all ye gullible

Sure thing

Sources and acknowledgements

Betting on gambling in Malaysia

The rancour over the Ascot sports betting saga needs a better context.

First, the Malaysian government has consistently demonstrated a level of pragmatism that should rightly be held up as a model of sensible governance in a multi-racial and multi-faith community. This cannot be disputed. This should be applauded.

Second, the propensity to gamble will always be there, particularly within the Chinese Malaysian community. We can argue till the cows come home. The fact will remain that gambling activity will remain significant in the Chinese Malaysian community. A good government will not ignore this social reality.

Third, if the Malaysian government chooses to be cowed by moralistic shouting by certain quarters it will have failed to act responsibly to deal with an obvious activity that fertilises the criminal elements in Malaysia. There is a trade-off between being moralistic in a crime-infested community and to practice hardnosed governance by regulating a hitherto "black economic activity".

(Yes, naysayers can cleverly point to prostitution and drugs as other examples of the "black economy" but such arguments can be said to being too clever by half. This is not a luxury that a responsible government can afford to indulge in).

Why not an open tender?
That said, the point raised by detractors who asked why an open tender was not made does require a straight answer from the Malaysian government.

If there was, indeed, a "first right of refusal" given to Ascot, then, can the rakyat have a look at the document?

If not, why not?

This has to be answered. If no answers are forthcoming, this Malaysian government can expect strong cries of cronyism.

If there are sound legal reasons which will give Ascot a sure-win in the Courts over the Malaysian government, then, the rakyat would want to know whether the Attorney-General has rendered a legal opinion on the matter.

Poor spin control
As I have said in a previous short post on sports betting, the ineptitude in handling the matter is astounding.

The sensible playbook should have been as follows:

First, get the law enforcement people to seriously clamp down on illegal gambling activities. Arrests must be made. Charges must be written up. Books must be thrown at gambling syndicates.

Second, get the media to trumpet these arrests and charges.

Third, get the law enforcement people to provide fresh estimates on the incidence of illegal gambling. (Yes, it's been done umpteen times. But, hell, the public has a short memory and attention span. Do it again and again.)

Fourth, get the politicians and NGOs to decry the incidence of illegal gambling activities. Link it to criminal activities (which is obvious).

Fifth, repeat steps one to four several times over the span of at least one month.

Sixth, then, announce the grant of the sports betting franchise.

But, wait, the idiot who stands to receive the franchise needs to be grabbed by the collar and told in no uncertain terms that he must not, at all cost, strut his stuff in the public arena. He must call in the professional spinners (aka media and public relations people) to disseminate public statements in an orderly and controlled manner.

No off-the-cuff verbatim remarks are permitted.

Seven, make sure that the recipient establishes a major effort, no expenses spared, for round-the-clock gambling addiction counselling services.

Eight, highlight the gambling addiction counselling services. Get expert psychologists to write about or, be interviewed, on how the modality of gambling addiction counselling will be provided.

And, of course, even with all that there will be no stopping brickbats from being thrown.

But, at least, you will have been better prepared than to lamely answer questions in Parliament by replying that the sports betting licence has not been given ... yet.

Why no open tender?
All eight steps will not answer why no open tender was conducted.

That question needs to be answered by the Malaysian government.

Sports betting

I am astounded by how inept this whole matter of granting a sports betting licence has been handled by both the issuing authority and the recipient.

From the speed at which the approval (or approval-in-principle or grant or bequest or conditional approval or whatever it will be called) was given to the bravado and in-your-face machismo displayed by the recipient, it has all the characteristics of a fiasco from the get-go.

What a joke.

So, what we have is this. Imagine it being sung by the relevant persons:

This one will never sell,

they'll never understand,

I don't even sing it well,

I try, but I just can't.

-Barry Manilow: This One's For You-

Early Buffettology

Way back in March, 1982, Warren Buffett was not an immediately recognisable brand name. But, he was already a significant investor with an equity portfolio of USD600 million. Compared to Berkshire's current asset value of USD300 billion and a market capitalisation of USD150 billion, that 1982 equity portfolio may seem a trifle small.

Such a view would belie the importance of content and substance over form.

In a letter dated 5th March 1982, Buffett had written to a legislator warning against the rise of derivative securities products. Anyone who has read my earlier posts on derivatives will know how sceptical I am about this dubious securities instrument.

So, I was delighted to read that Buffett had held a similar view way back in 1982 when derivatives began to gain some measure of ascendancy. In that maiden wave, derivatives reached its apogee with the likes of Michael Milken and junk bonds.

I was even more delighted to discover that to enlighten the said legislator, Buffett had equated derivatives to gambling products offered in places like Las Vegas.

Here's an extract of Buffett's letter as reported:

In the 1982 letter Buffett argued that the "propensity to gamble is always increased by a large prize versus a small entry fee, no matter how poor the true odds may be. That's why Las Vegas casinos advertise big jackpots and why state lotteries headline big prizes." By small entry fee he was referring to the cost of buying or selling an option or futures contract on the S&P 500 index, a small fraction of the index's market value.

"In securities," Buffett argued "the unintelligent are seduced by low margin requirements through which financial experience attributable to a large investment is achieved by committing a relatively small stake." Harking back to the wild markets of the 1920s when the boom in stocks was accentuated by 10% margins, Buffett warned that "10% down payments" are simply a way around the margin requirements and will be immediately perceived as such by gamblers throughout the country." In ending the four-page letter Buffett warned that "the net effect of high-volume futures markets in stock indices is likely to be overwhelmingly detrimental to the security-buying public and, therefore, in the long run to capital markets generally."

If that is Buffett's damning observation of derivative products, there is hardly any doubt as to his views on gambling as an activity.

Hit Me Again! The Gambling Brain

I have always thought very lowly of the propensity of people to make wagers. It has never made any sense to me.

I have always eschewed chance and favoured certainty. If that makes me a boring person, then so be it.

While taking risks are part and parcel of the business world, those of you who are involved in new business development would understand what I am saying when when I say that in spite of inherent risks in embarking on new business ventures, sound acumen requires us to turn our minds to the reduction and minimisation of risk so that the chances of success (i.e. profitability) is more certain than not.

In this sense, the recent award (or, for the pedantic reader, re-award) of the sports betting licence by the Malaysian Government and, the subsequent corporate exercise, resulted in a positive market reaction (even if it has created indignation among socio-religious groups). The rewards of gambling to the promoters of gambling are a certainty.

On the flipside, the rewards of gambling to the gambler is uncertain; hence the public opprobrium on the perils of gambling.

So, here we are.

Sharon Begley, Newsweek's science editor wrote this interesting piece that focuses on the behaviour of gamblers and how promoters of gambling prey on specific behaviourial patterns exhibited by gamblers. The focus of the piece is on slot machine design. But, it has equal relevance to any form of gambling:

When there is a commercial motivation to understand and exploit the human mind, business gets there before science. Case in point: the power of near-misses to keep gamblers glued to a slot machine.

As anyone who has come oh-so close to winning a computer solitaire game and been unable to resist clicking "new game," or who has found it harder to walk away from a slot machine after spinning two bells and a lemon (a near-miss) than after getting a bell, a lemon, and a three-bar (a total miss), knows, near-misses are like crack. The reason, according to a paper in the current issue of The Journal of Neuroscience, is that near-misses raise activity in the exact same reward circuitry of the brain as wins do. And in a finding that offers insight into problem gambling, the brains of problem gamblers react more intensely to near-misses than casual gamblers do.

The reward circuitry runs on the neurotransmitter dopamine, which has been widely, if simplistically, called the brain's reward chemical. It is such an all-purpose molecule that it underlies the pleasure we get from (and, for some, the addictiveness of) drugs, alcohol, sex, chocolate, gambling, and (for the psychopaths among us) even causing others pain.

For their study, led by Luke Clark of the University of Cambridge, researchers recruited 20 volunteers. Their gambling habits ranged from buying a lottery ticket occasionally to making regular bets on sports. The volunteers played a computerized slot machine with two spinning wheels. When two pictures matched, the volunteer won 50 pence (about 75 cents). No match, no payoff. At the same time, the volunteers had their brain activity measured by fMRI, functional magnetic resonance imaging .

As expected, wins activated the reward pathways in the region called the midbrain. But so did a loss in which the second icon was right above or below the one that would have matched the icon on the first wheel—a near-miss. Since the bursts of dopamine indicated by the brain activity bring a sense of reward and keep people coming back for more, the fact that they are as intense as the bursts that follow a win suggests an explanation for the power of near-misses to keep people gambling. Although losing feels subjectively lousy, near-misses nevertheless spritz the brain with the dopamine that makes a behavior addictive.

The psychology behind this seems to be that people who play slot machines or the lottery, where wins and losses are the result of pure chance, often mistakenly believe that skill is involved. This illusion of control ropes gamblers into trying their luck after a near-miss. Compulsive gamblers have it worst: their brains reacted much more to near-misses than did the brains of casual once-a-month lottery players.

In a paper last year in the journal Neuron, Clark and his collaborators laid the groundwork for the latest finding. There, they reported that although near-misses while playing a slot machine felt less pleasant than wins (duh), they increased the desire to play just as much as long as players felt they had some control over their spins—supporting the idea that the illusion of skill underlies the phenomenon. (When the slot machine was rigged so that the computer chose what icon appeared on the first wheel, and thus what the second wheel would have to match for a win, players felt less control than when they were allowed to choose the left icon. Players seemed to feel that if they were permitted to choose, say, an orange as the icon to match, they had a higher chance of winning.) Near-misses, by activating the same circuitry that winning money does, "invigorate gambling through the anomalous recruitment of reward circuitry," Clark and his team wrote. But that study used ordinary people with no particular gambling habit, mild or intense. The current one shows that near-misses have even greater power over problem gamblers.

A little digging finds that although neuroscientists may be just figuring out the power of near-misses to keep gamblers playing, slot-machine makers have known about it for decades. In a 2008 study, scientists analyzed how "slot machine manufacturers use virtual reels and a technique called 'award symbol ratio' to create a high number of near misses above and below the payline"—that is, so that the losing icon appears right above or below the winning cherries, lemons, or whatever. Thus we see yet again that when there is money to be made by understanding the brain, business beats science.

Casino and NFO tax increases in Budget 2008

Malaysia's Budget 2008 is likely to impose a gaming tax hike. The Malaysian government needs to maintain the budget deficit at 2.3% of GDP. Malaysia's gaming industry comprising numbers forecast operators (NFO) that conduct online 4D and Lotto games will provide an additional source of financing to contain the budget deficit.

The recent imposition of windfall taxes on independent power producers (IPP) and oil palm plantation companies lend further credence to this view.

Tax risk on NFOs

The last revision for NFOs (from 7% to 8% of gross revenue) and casino (from 22%-25% to 25% flat of gross revenue) were 10 years ago. NFOs’ betting duty was standardised from 6%-12% to 6% of net revenue in 2003.

It is estimated that every 1% hike in gaming tax would add about RM100 million or 4% to the Malaysian government’s annual gaming-related revenues of RM2.6 billion which comprises less than 1% of the government’s total annual revenue.

Tax risk on casino operations

It is felt that casino operations are even more vulnerable to tax risk in Budget 2008 than NFOs due to its more significant revenue contribution. In 2007 government revenues from casino operations was RM1.4b. This constituted a whopping 55% of total gaming tax revenues. 

Casino operations are regarded as being relatively more resilient demand. The Malaysian casino's grind market - an industry term for retail-type gamblers, as opposed to high-rollers - constitute a significant 70% of Malaysian casino revenue.

Risk impact

The tax hike, if any, is unlikely to be substantial. Malaysian casino’s present gaming tax of 25% is already Asia’s second highest after Macau’s 39%. In contrast, Singapore is considering a 15% tax the for grind market and 5% for the high-roller segment.

A huge increase will erode Malaysian casino's competitiveness, especially in the thinner-margin high-roller segment, as it reduces flexibility in offering rebates and commission to boost casino patronage. Industry observers believe that there is a possibility of the Malaysian government introducing a two-tier gaming tax similar to Singapore's model.

Penang's public transportation: A radical solution

I like radical solutions. They push the envelope of conventional thinking. I want to propose a radical funding solution for the Penangites for Trams Campaign. I very much believe that this Campaign makes absolute sense in the context of Penang Island which is compact, densely populated and, a magnet for tourists. The general merits of the Campaign are very well set out in the URL link above. It is unnecessary for me to go into it.

Instead, I want to address only a few key issues that, in my humble view, will advance the cause of the Campaign. I hope the Campaign members will take this up and, I will be happy to embellish and develop the propositions, if called upon.

1. Set up a Penang Tram Foundation

The Campaign needs to go beyond the ranting and platitudes and step up the process. This can be done by incorporating a company limited by guarantee. I'm suggesting the name Penang Tram Foundation.

The basic charter of the Foundation is simply to promote and establish a public tram system for Penang.

2. Sidestepping the thicket of legalities

The Foundation, being a private entity (as opposed to the Penang State Government) has a just cause in the public interest to propose the establishment of a comprehensive tram system for Penang. The Foundation can meet the constitutional issues on infrastructure development being under the federal government by sending a formal proposal in the public interest.

3. Funding methodology: Public lottery

This is where I get radical. The Foundation should establish a public lottery to partially fund and finance the initial studies and surveys on the tram routes, the construction issues and tram technology to be deployed. The Penang Tram Lottery (a working name) will also be used to fund and finance the construction of the tram route, pay for any land acquisition required to create the route, the acquisition of the trams and, the subsequent tram operations.

4. Rationale for public lottery as a public finance device

The Campaign is clearly promoting the tram idea because it ameliorates the public transportation woes of Penang. It is a public-interest proposition since public transportation is a Public Good. And, if the federal government is reticent about solving the obvious public transportation woes of Penang, then the Foundation is a good vehicle to formalise the Campaign.

A public lottery is a form of public finance. It's economic merits are manifold if the goal is to create a public good. For a more technical economic analysis of the merits of lotteries as a means of financing public goods, please read John Morgan (of Princeton University) in an article entitled Financing Public Goods by Means of Lotteries.

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As I said, I like radical solutions. I very much believe that the issue of public transportation in Penang is a very serious matter that is already affecting the economic competitiveness of the state. The poor public transportation infrastructure is also having a deleterious effect on Penang's tourism.

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See also a related blog entry made earlier that provides a wider context to the public finance via public lottery proposition contained above at The Malaysian problem with privatisation of public goods.

The Malaysian problem with privatisation of public goods

Roads, water, electricity and public transportation are public goods. This means that usage of roads, taxis, trains, LRTs and buses by one individual does not reduce the amount of the good available for consumption by others; and no one can be effectively excluded from using those "goods".

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Privatization is the process of transferring ownership of business from the public sector (government) to the private sector (business). Malaysia's first privatisation was Sports Toto in 1985.

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Have M'sians benefited from privatisation?

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Have Malaysians benefited from privatisation? There's no easy answer for that. But benefit we can see (and experience) is the quantum leap in economic development and business activity over the past 2 decades. The impact of privatising "public goods" can be seen in the increase in the number of kilometres of roads which has opened up many parts of Malaysia. This increased accessibility has engendered more economic activity, particularly property development and domestic tourism.

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But, we have also been sceptical about the necessity of privatising other public goods, in the sense that many Malaysians believe that the government agencies and statutory bodies that were responsible for these public goods could have done just as good a job.

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For example, in the area of electricity, many of us believe that the old Lembaga Letrik Negara or Tenaga Nasional Berhad ("TNB") could (and, still can) do as good and, as efficient, a job as the Independent Power Producers ("IPP"). Many of us are aghast at the lop-sided Power Purchase Agreements ("PPA") that TNB was forced to sign with the IPPs. We tend to feel that the cost of our electricity has become more expensive due to privatisation.

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Or, take the case of the privatisation of water. Many of us feel that the quality of treated water has worsened. Certainly, the privateers have not addressed the urgent matter of leaking water pipes that causes wastages. The cost of that inefficiency is being passed to us consumers.

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We also feel perplexed when the same government that has assiduously promoted car ownership also blames us for selfishly causing traffic jams and, worse still the same government cannot provide an efficient public transportation so that we can leave our cars at home (so as not to cause traffic jams)! How many productive man-hours have been lost in traffic jams? Or, for that matter, how many quality leisure hours have been lost? Those are costs to us as individuals and, for the Malaysian economy and society.

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Analysing "public choice"

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The expression "public choice" is actually a socio-economic tool of analysis. Public choice is often referred to when discussing how individual political decision-making results in policy that conflicts with the overall desires of the general public.

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For example, many special interest and pork barrel (pardon the American lingo) projects are not the desire of the overall community. However, it makes sense for politicians to support these projects. It may benefit them psychologically as they feel powerful and important. It can also benefit them financially.

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The politicians pays little to no cost to gain these benefits, as they are spending public tax money. Big businessmen are also behaving rationally. They can gain government favors worth millions or billions for relatively small investments.

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The taxpayer is also behaving rationally. The cost for an individual taxpayer of defeating any privatisation project is very high, while the benefits to the individual taxpayer are very small. Each citizen pays only a few sen or a few ringgit for using any of these public goods, while the costs of stopping or cancelling such projects would be many times higher.

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So, everyone involved has rational incentives to do exactly what they're doing, even though the desire of the general constituency is opposite!

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That seemed to be the case for Malaysia until the General Elections of March 8, 2008.

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Alternatives to privatisation

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As we know, "privatisation" is a 1980s and 1990s expression. Now they call it "private finance initiatives". It doesn't matter how finance people deny it, as far as I can tell, it means the same thing.

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Malaysians have always been sceptical about the efficiency of the civil service. But, let us not forget that the revamp of the Immigration Department and National Registration Department was successfully done. No more complaints have been heard. The Road Transport Department is still rubbish, though. But change is possible if there is political will.

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Let us also consider the corporatisation of the Securities Commission, the Companies Commission and, even the Inland Revenue Department. We cannot deny that performance has improved.

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So, do we really need privatisation? The answer is a qualified NO! The qualification is that certain things must be put in place in order to get rid of privatisation:-

• Appointment of management and supervisory staff must be strictly on merits, not ethnicity.
• Salaries and wages must be competitively matched against equivalent positions in the private sector.
• Accountability and governance must be strictly monitored. Quarterly audits of finances and management processes by public accounting firms must be made mandatory. Their reports must be made public. No different from companies listed on Bursa Malaysia.
• Regular parliamentary scrutiny must also be made a feature.

That still leaves the matter of how to finance these projects. Let's look at the alternatives to the privatisation financing model:-

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a. Government or Sovereign Borrowing

• Obtain loans from other countries or international funds.
• Borrowing from private financial institutions or issuing debt instruments like bonds - These transactions create sovereign debts. The only issue is the mode of repayment and, interest and currency risk.
• Issue Treasury Bonds aka Malaysian Government Securities.
  

b. Mandatory Taxation

• Income tax.
• Sales and value-added tax.

c. "Voluntary Taxation"

• Lotteries.
• Public charities and donations.

Let us not forget that the ordinary citizens and taxpayers will still be required to pay to use any of the public goods. This is a source of revenue. It won't be for free, of course.

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"Voluntary taxation" via lotteries as a form of public finance has been abandoned since the 1980s. As mentioned earlier, Sports Toto was a statutory body until it was privatised in 1985. It was intended to be a vehicle to raise funds for the development of sports in Malaysia. Sadly, with privatisation the original objectives have disappeared.

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Before the repeal of its legislation, the social welfare lottery was a key public finance vehicle for the welfare and services ministry. In its earlier guise, it was a lottery managed by the Malaysian Chinese Association.

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What is so fundamentally wrong if this form of voluntary taxation is now deployed as a government policy to fund projects such as:-

• Roads, highways and bridges (yes, even the 2nd Penang Bridge!).
• Subsidise public transportation.
• Education scholarships.
• Sports development.
• Tourism-related projects.
• Micro-financing.
• Welfare schemes.

The beauty of a voluntary tax is that the "taxpayer" who buys the lottery, sweepstake or 4-Digit number is HAPPY to part with his money. We cannot say the same for the taxpayer who pays his tax assessment.

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If we combine the reported annual sales turnover of all the entities involved in lotteries, gaming and wagering in Malaysia, we have about RM12 billion. Assuming RM7 billion is used to pay prize monies and RM2 billion is used for operating expenses (and whatever else), there is still RM3 billion available for public finance. Think about it!

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Just let charitable public foundations have the annual licences issued by the Ministry of Finance. Trustees of these public foundations are allowed a tenure of 2 terms of 2 years each. Their accounts, charitable donations and disbursements must be audited quarterly by reputable firms of public accountants. As public foundations, they must be subjected to parliamentary scrutiny.

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Lottery operations can be outsourced on 5-year contracts. Tenders and proposals must be public. Tender committees must be outsourced to combined committees of public accounting firms and law firms.

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The lurking suspicion one has is that whether it is BN or Pakatan Rakyat that runs the federal government, this form of voluntary taxation will NOT take place. It's a political "hot potato" on irrelevant considerations such as social morality or religious sensitivity. Oh! Let's not forget the powerful lobbying from the businessmen who have a vested interest in these lottery, gaming and wagering ventures. Can Makkal Sakhti happen in the area of public goods management and financing?

Gaming & Wagering Laws in Malaysia

Gaming and wagering is a strictly regulated activity in Malaysia. The Malaysian Contracts Act reflects this position by providing that all gaming and wagering contracts are void.

However, gaming and wagering is permitted by licensing or exemption. There is a plethora of statutes that regulate gaming and wagering activities in Malaysia:-

• Pool Betting Act
• Betting Act
• Lotteries Act
• Common Gaming Houses Act
• Racing (Totalisator Board) Act
• Racing Clubs (Public Sweepstakes) Act

Specialised gaming and wagering revenue collection statutes are:-

• Gaming Tax Act
• Betting and Sweepstakes Duties Act
• (Pool betting duty collection is provided in the Pool Betting Act)
• (Lottery duty collection is provided in the Lotteries Act)

Repealed statutes on gaming and wagering include:-

• Social Welfare Lotteries Act
• Gaming Ordinance of Sabah (Cap.50)
• Gambling Ordinance of Sarawak (Cap.138)

Corporations or clubs in Malaysia that are licensed to conduct forms of gaming and wagering include the following:-

• Tanjong plc (its subsidiary Pan Malaysian Pools Sdn Bhd)
• Pan Malaysian Sweeps Sdn Bhd
• Selangor Turf Club
• Perak Turf Club
• Penang Turf Club
• Sports Toto Malaysia Bhd
• Magnum 4D Bhd
• Sandakan Turf Club
• Everise Ventures Sdn Bhd
• Royal Sabah Turf Club
• Keningau Turf Club
• Sarawak Turf Club
• Natural Avenue Sdn Bhd
• Lotteries Corporation (88) Sdn Bhd

Apart from licensing and regulatory matters and corporate matters, substantive management and operational matters that are relevant include:-

• Game branding
• Game design
• Prize payout structure
• Retail outlet design
• Rules & regulations of games
• On-line computer vendor identification & negotiations
• Gaming software contract negotiations
• Training modules for staff
• Result-drawing machine vendor identification
• Drawing procedures

Dear Visitor,

You are welcome to contact me, CT Choo at my email c_t_choo@yahoo.com if you have any questions regarding the information above or, any related matters. I will try to answer your queries.

CT Choo