Attitudes toward gambling have shifted not only from state to state but also over time.  Twice before in American history, almost all gambling was outlawed.  Even Nevada closed its casinos in 1909.  But we are now in what I call the Third Wave of Legal Gambling, with state after state authorizing and then expanding legal commercial gaming.

Attitudes toward other activities with speculative elements have also shifted over time.  In the past, trading on futures contracts for commodities was seen as creating dangers at least as great as more conventional gambling.

If, instead of betting on something so small as falling dice, one bets on the rise and fall of stocks or on the price which wheat will reach some months hence, and if by such betting one corners the community in an article essential to its welfare, throwing a continent into confusion, the law will pay not the slightest attention. A gambling house for these larger purposes may be built conspicuously in any city, the sign “Stock Exchange” be set over its door, influential men appointed its officers, and the law will protect it and them as it does the churches.

In the American legal system, an activity that is prohibited can be made legal through the actions of legislatures or by courts.  A legislature usually legalizes a previously forbidden activity through express authorization, such as with casinos.  But lawmakers can also make an activity legal by simply eliminating the prohibition from the statute books.  In the United States, states and the federal government can only make something illegal by expressly spelling out in detail what exactly it is that from now on is not allowed.  Otherwise, the crime would be an unconstitutional denial of due process for failing to give people adequate warning and thus preventing them from conforming their behaviors to the requirements of law.

Courts also have the power to legalize an activity that was previously considered illegal.  This can be done by declaring that a specific activity does not fit the elements of the crime.  So, the Supreme Court of California declared the card game of bridge to not be gambling, finding it was predominantly skill.  But courts in the U.S. and other parts of the English-speaking world can also literally change the law.  They do this under their common law powers to declare that some elements of an activity must be present or absent either to fulfill public policy objectives or under the courts’ interpretations of state and federal constitutions.

The federal and virtually all state courts do not have the power to create common law crimes; the power to make an activity subject to criminal punishment is reserved to Congress and state legislatures.  But they do have the power to decide that an activity, like trading in commodities futures, is no longer violating civil and criminal restrictions imposed on gambling, if the commodities contracts have certain characteristics.

Agreements to take delivery in the future of goods with fluctuating prices were illegal and unenforceable for hundreds of years, as forms of gambling.  Then courts recognized that shifting the risk of changes in prices to speculators served a valuable function: The sellers, like farmers and producers, on the one hand, and, the buyers, like meatpackers and industrial bakers, could stay in business, even in the face of large, unexpected changes in the prices of the underlying commodities.

But the fight was not easy.  Populists, particularly those in agricultural states, fought for legislation to make commodities’ futures illegal.  They described commodities speculation as a form of “diabolical gambling.”  Opponents accused traders of not only gambling, but of wagering is a game the commodities speculators themselves had rigged.  The agrarians “returned to the rich cultural legacy of gambling.  In the 1880s and 1890s a corporate economy of speculative finance and mass production could, with the help of gambling metaphors, be imagined as an economy run from hell.”

Proponents of futures trading eventually won.  But, at first, they had to spend a lot of their effort trying to distinguish speculation in commodities from mere gambling.  One argument was that traders served a social function, while gamblers were seen as contributing nothing at best and antisocial at worst.  So, the gambler was seen as “not performing any service, since he is not assuming any economic risk which someone else desires to shift,” unlike the commodities speculator who is taking on risks that the producers and manufacturers wanted to avoid.

To deal with the strong anti-gambling feelings, courts created legal fictions that speculators in futures were actually real buyers and sellers of commodities.  The first contracts involved people buying and selling goods and deciding on the price.  It certainly could not be gambling if the contract simply said the delivery of the good would not take place until next month, or next year.  So, courts told speculators to simply lie and say they were going to take delivery of the goods.  Of course, true speculators never took delivery; they were merely hoping to sell the contract at a profit if the price changed in the direction they had bet.  Since they were commonly buying on margin, using borrowed funds to create leverage, and speculating on small changes in prices, speculators would have been devastated if they had to actually take delivery on tons of unwanted produce.

The U.S. Supreme Court was one of the first to recognize that trading in commodities futures served a public purpose.  In 1883, in one of the first cases, Rountree v. Smith, the plaintiff was a broker suing for services rendered.  The contracts were undoubtedly unenforceable wagers under the controlling state law.  The Court’s sympathy can be seen by its ruling in favor of the plaintiff, on the grounds that the defendant had not proved these were gambling contracts, because the defendant had no idea how the commodity exchange worked!

The next year, the Court spelled out the legal fiction it was going to require.  In Irwin v. Williar, the justices declared contracts for sale of grain futures to be illegal gambling transactions, but only because there was no bona fide intention to deliver the grain.

Brokers and speculators quickly learned how to play the game.  Within three years, the Supreme Court was upholding futures commodity contracts against challenges that they were gambling contracts, finding there were bona fide intentions to deliver.

A few years later, the Court made the legal fiction easier.  Instead of stating, falsely, that the buyer of a futures contract promised to take delivery of some enormous amount of produce, the contracts were upheld against challenges that they were illegal gambling contracts, because there was no understanding that the goods would not be delivered.   It took another 30 years before the Court expressly recognized the economic reasons behind allowing producers and buyers of commodities to shift the risk of changing prices to speculators.  In Browne v. Thorn, the Court ruled that “hedging” is prima facie lawful, manufacturers and others who have to make contracts for future deliveries can guard against price fluctuations.  If hedgers do not disclose their intentions not to accept delivery of the goods, no gambling contract is created.

Congress finally stepped in to end the debate, without requiring legal fictions.  The  Securities Exchange Act of 1934 expressly preempts state anti-gambling statutes:  “No State law which prohibits or regulates the making or promoting of wagering or gaming contracts, or the operation of ‘bucket shops’ or other similar or related activities, shall invalidate any put, call, straddle, option, privilege, or other security subject to this chapter, or apply to any activity which is incidental or related to the offer, purchase, sale, exercise, settlement, or closeout of any such security.”  Congress had to add that provision, and others similar to it, to federal laws regulating stock and futures markets, because too many states still have anti-gambling laws on their books that could be used against stock, bond and commodities trading.

But note that federal preemption does not apply to all trades.  A classic bucket shop, also called a boiler-room, is still gambling: the broker merely bets against the speculator without actually executing the trade on an exchange.  Some boiler-rooms do buy and sell penny stocks and other risky ventures on unregulated or foreign exchanges.  The federal statutes do not exempt state anti-gambling laws on these trades; so these are still illegal as gambling today.

Occasionally both proponents and opponents of legalizing gaming will point out that trading on stock and commodities markets is very similar to gambling.  Few realize that trading in securities, derivatives, etc., is not only similar, in the eyes of many state laws, it is still gambling.

The states may have been wrong on thinking that futures markets performed no economic function.  There is today general agreement that risk-adverse producers and consumers of commodities should have a way of transferring to risk-seeking speculators the chances of prices rising and falling before produce is delivered.  The economic theories have been extended to everyone who is holding a large quantity of anything valuable.  International companies need to be able to hedge against fluctuating foreign currencies and companies with large portfolios need to hedge against sudden changes in the prices of their securities.

But, as the crash of world markets and the Great Recession of the past few years have shown, gambling can lead to bubbles, which, when they burst, can affect the real world.  The problems arose from the confluence of changes in the law, often characterized as deregulation, and ever faster technology, especially computer trading.

For individuals, this has meant they can now bet on which way a stock or an entire market will go, with no interaction with human beings, to slow things down.  Any speculator can legally become a day-trader on listed exchanges, buying and selling securities and futures in even the biggest markets, directly online for his or her own account.  Before the advent of the Internet this was not possible.  Talking to a stock or commodities broker not only took time but also subjected the gambler to outside scrutiny.

The risks, behaviors and fates of many online day-traders are eerily similar to, if not indistinguishable from, those of online gamblers.  The comparison can in fact be made point for point: the very terminology is often interchangeable, in such phrases as “high risk – high reward games.”  Traders who “ride the losses” and reinvest are the counterparts of gamblers who “double down;” “using the news to evaluate underlying market conditions” is called “handicapping” when a gambler does it.  Likewise, both gamblers and speculators online are notorious for relying on software programmed “systems” and even “black boxes” of doubtful value to make winning picks for them.  The two groups even ignore the same wise warnings: never play with money you can’t afford to lose, never borrow your stake, set a limit for losses and stick to it.

The most striking statistic showing how “investing” can become mere “gambling” comes from the New Jersey Council on Compulsive Gambling, which reported receiving more phone calls after the 1987 stock market crash from gamblers who had lost everything betting on options than in the casinos in Atlantic City.

But the evolution of securities trading into gambling has had impacts far beyond the problems of individual speculators being wiped out.

Courts and then Congress understood that speculators in commodities markets never wanted to take delivery of the products they were betting on.  So, they eventually eliminated the legal fiction that required buyers to state that they stood ready to take actual delivery.

But in 1974 Congress greatly expanded what speculators could bet on.  It slipped an obscure provision into the Commodity Futures Trading Commission Act of 1974 allowing the Commission to approve contracts without a delivery being possible.  In 1982 the first futures on stock market indexes were introduced.  Congress then explicitly made these stock index contracts legal through the Futures Trading Act of 1982.  Everything now had the potential of becoming a commodity, including common stocks and sub-prime mortgages.

The Futures Trading Act was passed by Congress in 1982, ironically, to make the stock market less risky and to draw more individuals into the market.  The Act was meant to provide the means for a holder of a large portfolio of stocks to hedge his investment the way a farmer or food processor uses commodity futures as a hedge against changing prices.  Thus, the Treasurer of General Motors could protect his company’s large liquid assets against wild swings in the stock market the way General Mills protects itself against wild swings in the price of wheat and sugar.

Stock index futures were developed to allow major companies to hedge their portfolios.  In fact, the Commission could only approve a new type of futures contract if it found it would be useful for hedging.  General Motors, for example, needed a way to help its customers buy its cars.  Having a large financial company, like General Motors Acceptance Corporation, GMAC, available to make low-cost loans, increased sales of its basic products.  But GMAC is not going to keep its billions of assets in the form of cash; it invests in stocks.  Its goal is not to make enormous profits from its stock portfolio, but to have a safe place of readily convertible assets, that do increase in value over time and produce dividends.  GMAC and others like it argued that they needed a way to hedge, i.e. guard against sudden swings in the market.

The first bubble and crash, in 1987, came after computerized trading linked stock index futures on the commodities exchanges with shares in the actual stocks on the stock exchanges.  It is not surprising that the stock market became subject to speculation after the creation of stock index trading.  The main culprit was the easing of margin rates, allowing the essential element of high leverage to arise.  On October 19, 1987, a speculator wishing to buy $130,000 worth of stock would have had to put up 50 percent margin, or $65,000.  The same speculator, if classified as a hedger, could have taken a $130,000 position in the stock market by buying an index futures contract for an initial investment of $7,500, only 5.8 percent of the contract’s value.

Thus, a stock index future is a contract to buy or sell a hypothetical portfolio of stocks contained in an index such as the Dow Jones 30.  Like commodity futures, stock index futures are designed to attract speculators to bet against the large institutional hedgers.  They do this by offering extremely large leverage.  But, unlike commodities’ futures, the stock index future is a legal fiction: no stocks are actually bought or sold; in fact the holder of a stock index future cannot by law demand delivery even if he could come up with the money to buy the underlying stocks.  In effect, the speculator is simply betting on a number.

The federal government, somewhat naively, believed that no one would be able to manipulate the stock market to create artificial profits in stock index futures.  After all, who could afford to buy all the stock on the Standard and Poor’s 500 in such large quantities that it would change the prices of these 500 stocks?  The government ignored the fact that the stock market is a classic case of the tail wagging the dog, only a small percentage of a company’s stock is traded on any day.  There are any number of pension funds, insurance companies, and large corporations with the ability to wag a dog of any size.

What the large institutions discovered was that stock index futures did not always match perfectly the stocks they supposedly represented.  An extremely small difference in prices could be exploited — by anyone who had at least $10 million to invest.

The game could be played to the hilt once the stock exchanges and the large institutions became computerized and multi-million-dollar blocks could be bought and sold instantaneously.  Profits can now be locked in by buying a stock index future while, at the same time, selling the same stocks that index supposedly represented; and vice versa.

Even better, for the big traders, the cycle of buying and selling can often be exploited hour after hour, as prices on the stock market continue to rise or fall out of proportion to the futures.  The very act of buying or selling hundreds of millions of dollars via computer causes profitable discrepancies to continue.  For the traders this means increased profits.  For the other investors it means a market that can skyrocket out of sight or drop like a rock.

There is no dispute that individual investors were using stock index futures trading for pure speculation; this had to occur if risk-averse institutions were to be able to engage in hedging. However, a study done before the October 1987 stock market crash showed that 90% of the institutional investors themselves, who were supposedly using stock index futures to hedge, were actually using them to speculate.

Since then, there has been no turning back.  Calling the global securities markets a casino is an insult to casinos.  At least in casinos the regulators know how the games are played.

So, we have perhaps come full circle. Trading in commodities’ futures was seen as a form of evil gambling, which contributed nothing to society. After many years, hundreds of court cases and finally federal legislation, trading on listed exchanges was declared, as a matter of law, to be not gambling.  But technology and greed have now trumped the law.  Perhaps it is time for the law once again to treat trading in all securities, but especially exotic derivatives and futures contracts, as gambling.  That way government can protect speculators at least as well as it protects casino patrons.  More importantly, if the markets are seen as the pure gambling they have become, there should be less opposition to once again imposing strict regulations and controls.