An Economist Walks into a Brothel Read online

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  An imprint of Penguin Random House LLC

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  Copyright © 2019 by Allison Schrager

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  Library of Congress Cataloging-in-Publication Data

  Names: Schrager, Allison, author.

  Title: An economist walks into a brothel : and other unexpected places to understand risk / Allison Schrager.

  Description: New York : Portfolio, 2019.

  Identifiers: LCCN 2019001343 (print) | LCCN 2019015395 (ebook) | ISBN 9780525533979 (ebook) | ISBN 9780525533962 (hardback) | ISBN 9780525542827 (international edition)

  Subjects: LCSH: Decision making. | Choice (Psychology) | Risk management. | BISAC: BUSINESS & ECONOMICS / Decision-Making & Problem Solving. | BUSINESS & ECONOMICS / Economics / Theory. | PSYCHOLOGY / Social Psychology.

  Classification: LCC HD30.23 (ebook) | LCC HD30.23 .S377 2019 (print) | DDC 338.5—dc23

  LC record available at https://lccn.loc.gov/2019001343

  Penguin is committed to publishing works of quality and integrity. In that spirit, we are proud to offer this book to our readers; however, the story, the experiences, and the words are the author’s alone.

  While the author has made every effort to provide accurate internet addresses and other contact information at the time of publication, neither the publisher nor the author assumes any responsibility for errors or for changes that occur after publication. Further, the publisher does not have any control over and does not assume any responsibility for author or third-party websites or their content.

  Version_3

  Contents

  Title Page

  Copyright

  Chapter 1

  INTRODUCING RISK: THE WHAT AND UNUSUAL WHERE OF IT

  WHAT IS RISK?

  BROTHEL-NOMICS

  FINANCE: THE SCIENCE OF RISK

  THE RULES OF RISK

  THE WORLD GETS RISKIER AND YOU CAN OWN IT

  RULE 1: NO RISK, NO REWARD

  Chapter 2

  REWARD: GETTING WHAT YOU WANT TAKES KNOWING WHAT YOU WANT

  THE MINIBON

  THE PRICE OF RISK-FREE

  RISK-FREE FOR ME, BUT NOT FOR THEE

  Chapter 3

  TAKING A RISK: WHEN TO REJECT SAFETY AND GO FOR MORE

  SOMETIMES EVEN ECONOMISTS GET RISK-FREE WRONG

  RISK-FREE RETIREMENT

  Chapter 4

  RISK MEASUREMENT: HOLLYWOOD’S NEVER-ENDING QUEST FOR CERTAINTY

  THE LAND OF BROKEN RISK MODELS

  TURNING DATA INTO RISK: WHAT NORMALLY HAPPENS

  THE MOVIE BUSINESS: SKEW YOU

  THE PAST IS A LOUSY WAY TO PREDICT THE FUTURE

  TERRIBLE IS THE BEST WE’VE GOT, AND IT’S COMING TO A THEATER NEAR YOU

  Chapter 5

  DIFFERENT TYPES OF RISK: THE SECRET LIVES OF THE PAPARAZZI

  THE PAPARAZZI’S GOLDEN RULES

  THE PAPARAZZI GOLD RUSH

  IDIOSYNCRATIC VERSUS SYSTEMATIC RISK

  IT PAYS TO KNOW THE DIFFERENCE

  THE PAPARAZZI ARE JUST LIKE US TOO

  WHY WE FEEL SO MUCH ECONOMIC ANXIETY

  RULE 2: I AM IRRATIONAL AND I KNOW IT

  Chapter 6

  PROSPECT THEORY: TILTING TOWARD RATIONALITY

  YOU CAN’T SPELL HELLMUTH WITHOUT HELL

  WHY WE HATE TO LOSE

  BREAK-EVEN EFFECT AT WORK: THE WORLD OF ONLINE POKER

  DOES IT MATTER IF WE ARE IRRATIONAL?

  HOW TO TAKE RISKS LIKE A POKER CHAMPION

  Chapter 7

  RISK MISPERCEPTION: I NEVER THOUGHT I’D GET CAUGHT

  CRAZY, INDEED

  WE ARE ALL LOUSY AT UNDERSTANDING PROBABILITIES

  THINKING PROBABILISTICALLY ISN’T NATURAL

  HOW TO TAKE CONTROL

  RULE 3: GET THE BIGGEST BANG FOR YOUR RISK BUCK

  Chapter 8

  DIVERSIFICATION: LOOKING FOR EFFICIENCY IN ALL THE WRONG PLACES

  PITY THE TEASER

  THE STUD MARKET IS INEFFICIENT

  HOW BREEDERS REDUCE THEIR RISK

  INBREEDING

  THE BENEFITS OF DIVERSIFICATION

  A SELF-DESCRIBED NERD STARTS A REVOLUTION

  HORSE BREEDING’S ANSWER TO HARRY MARKOWITZ?

  RULE 4: BE THE MASTER OF YOUR DOMAIN

  Chapter 9

  DE-RISKING: THE ART OF THE HEDGE

  HEDGING

  INVEST MORE IN A RISK-FREE ASSET

  BUY SOMETHING THAT GOES UP WHEN ANOTHER THING GOES DOWN

  NEGATIVE HEDGE: MORE RISK, MORE REWARD

  HEDGING THE FUTURE OF CRUISING

  Chapter 10

  INSURANCE: INTRODUCING THE SPECTACULAR STOCK OPTION

  INSURANCE IS MAGIC

  OPTIONS

  THE GREEKS KNOW RISK

  INSURANCE IS MAGIC WITH CONTRACTS

  ARE OPTIONS AN ILLUSION?

  Chapter 11

  MORAL HAZARDS: SURFING BIG WAVES WITH INSURANCE

  BIG WAVE SURFERS ARE JUST LIKE ACTUARIES, ONLY WITH BETTER TANS

  BROTHERS FROM ANOTHER MOTHER

  80-FOOT WAVES IN FINANCE

  THE GOLDEN AGE WASN’T SO GOLDEN

  HOW CAN WE DO BETTER?

  RULE 5: UNCERTAINTY HAPPENS

  Chapter 12

  UNCERTAINTY: THE FOG OF WAR

  THE BATTLE OF 73 EASTING

  UNKNOWN UNKNOWNS

  DOOMED TO REPEAT HISTORY BECAUSE WE ARE OFTEN BLIND TO UNCERTAINTY

  HOW TO DEAL WITH UNCERTAINTY

  WHAT WE ALL NEED TO LEARN FROM THE MILITARY

  FINAL THOUGHTS

  Acknowledgments

  Notes

  Index

  About the Author

  Chapter 1

  INTRODUCING RISK:

  The What and Unusual Where of It

  The revolutionary idea that defines the boundary between modern times and the past is the mastery of risk: the notion that the future is more than a whim of the gods and that men and women are not passive before nature.

  —PETER BERNSTEIN, AGAINST THE GODS

  Despite the bright Nevada sun, the room was dark and the air stuffy; an obscure I Love Lucy rerun played on mute. A bell rang and a nondescript, pudgy man entered. Suddenly about a dozen women came running from a maze of long hallways, whooshed past me, and lined up in the foyer. Each woman folded her hands behind her back, stepped forward, and said her name. The man pointed to the second woman on the left, a zaftig platinum blonde wearing a red thong and lace bra. She took his hand and led him to her room.

  Welcome to the Moonlite BunnyRanch. A legal brothel is perhaps not where you would expect to find an economist who specializes in retirement finance, but I’m an unusual kind of risk junkie. I hunt risk to understand it better. I don’t seek out adrenaline-charged situations. I’ve never bungee jumped, I don’t ski, and I may be the only New Yorker who is afraid to jaywalk. Rather than look for risky situations for the rush of defying the odds, I search for unusual places that can teach me more about risk and how to manage
it.

  I was trained to shape policy, advise captains of industry, or write research papers at a university. And yet there I was, sitting on a red velvet sofa in a vinyl-sided house in a remote corner of Nevada because unusual markets like sex work thrive on risk. We can always find better ways to measure and reduce risk, so I go wherever people might be defying the odds. After all, financing retirement when you don’t know if the stock market will soar or crash, or how long you will live, requires mastering risk.

  Sex work is a risky business. I went to Nevada to understand how the industry isolates and assigns a price to this risk. Most sex workers and their clients could be arrested or subject to violence. Sex workers who find their customers on the streets are thirteen times more likely to be murdered than the general population. Thirty-five percent of sex-worker homicides are committed by serial killers. Paying for or selling sex carries a stigma: sex workers and their customers face social, professional, and legal repercussions if they are caught. I went to the brothel to understand what it costs to eliminate this risk.

  WHAT IS RISK?

  When people hear the word “risk,” they automatically think of something terrible, the worst-case scenario, like losing their job, their wealth, or their spouse.

  But we need to take risks to make our lives better. We must gamble to get what we want, even if it comes with the possibility of loss. If we want a great relationship, we risk heartbreak. If we want to get ahead at work, we have to volunteer for projects that we might fail at. If we avoid risk, our lives won’t move forward. Technically, risk describes everything that might happen—both good and bad—and how probable each of these outcomes is.

  Even the history of the word “risk” illustrates our complicated feelings about the concept: it derives from rhizikón, an ancient Greek seafaring term that describes a dangerous hazard. Though its usage evolved slightly over the years, it always described something perilous. But the meaning changed in the sixteenth century, when exploration of the New World began, and people started to think about risk as something controllable—not left to fate. The Middle High German word rysigo means “to dare, to undertake, enterprise, hope for economic success.”

  Whether you realize it or not, you take risks large and small, every day, in all parts of your life. The good news is that you don’t have to leave it all up to chance and hope for the best. This book will show you how to mindfully take a risk and minimize the possibility that the worst will happen.

  We are often taught to think of decisions in terms of “if I do X, then I’ll get Y,” but in reality any time we make a decision, a range of Ys could happen, from a superior Y to a terrible outcome. Once we recognize this, we can take steps to alter the range of Ys. We can’t guarantee a positive outcome, but when we think about risk more strategically we can increase the odds that things will work out. This is sometimes called taking a calculated risk, but there is a science to risk that helps you understand what is worth trying and how to maximize the chance of success when you do take a risk.

  The science of risk I’m referring to comes from financial economics. While you might be imagining men with slicked-back hair and fancy suits trying to make money—or take yours—most of what goes on in financial markets is simply buying and selling risk. Risk in finance is an estimate of everything that might happen to an asset—say, the odds of a stock going up 2 percent or 20 percent, or dropping 60 percent. Once risk is measured it can be bought or sold: people can choose to increase risk or reduce it, according to their preference. Financial economics studies risk in financial markets, but its lessons can be applied to any market or decision we encounter in our lives.

  For example, like any risk scholar, I would never take a New York City crosstown bus, because travel time is totally unpredictable: it takes thirty minutes on average to cross the island of Manhattan via bus, but commutes of more than an hour or as short as fifteen minutes are possible, depending on the day or time. If I walk, it takes thirty-five minutes—every time. When I walk, I don’t have to worry about excessive traffic or lots of stops to let people on and off the bus. Walking crosstown is almost perfectly predictable, and for me takes just about as long as riding the bus. To put it in terms of financial economics: if you need to decide between two portfolios with similar returns, choose the one that is less risky.

  These lessons from financial economics can be useful whenever we need to make a risky decision, but most of us never learn them. I have a PhD in economics, but I didn’t learn much about finance until I finished graduate school. I had assumed financial economics was simply the study of how people try to beat the stock market to get rich. While that’s part of it, because increasing risk offers the possibility of making more money, financial economics is more than that: it is the study of risk.

  As I learned more about financial economics, I started to see how its market-based lessons on risk could translate into a new way to understand and see the wider world. Knowing how to use these tools would empower us to make better complex risky decisions every day, from deciding to go back to school or take a job at a start-up, to allocating an amount of time to work on a project or determining how much to bid on a dream house.

  The economics of risk are everywhere. When writing this book, I did something economists rarely do. Rather than sit at my desk at home and just look at data, I spent many hours in the company of noneconomists, far from Wall Street, and asked them how they manage risk in their lives and careers.

  Everyone I interviewed has found clever ways to identify and manage risk in a rapidly changing economy. Their stories illustrate the most important principles of financial economics better than any story about the stock market ever could.

  BROTHEL-NOMICS

  The owner of the Moonlite BunnyRanch when I visited was Dennis Hof, a large, slightly hunched, bald man in his seventies who had an imposing presence. He often wore a bowling shirt and khaki pants and walked the halls of the brothel flanked by young blondes vying for his attention and approval. Hof died in October 2018 at the age of seventy-two, found in his luxury suite at one of the brothels by porn star Ron Jeremy.

  Hof grew up a beloved only child in Arizona. In high school he worked at a gas station, knocked up his girlfriend, and married her. Soon after, Hof started buying gas stations; he sold gas illegally during the 1970s energy crisis and pocketed a small fortune. He had a series of affairs and his marriage fell apart. Hof moved to San Diego, started a business selling time-shares, and befriended people in the porn industry. He also became a regular customer at Nevada’s legal brothels.

  The only places in the United States where selling sex is lawful are a handful of counties in Nevada, where the industry is heavily regulated. Licit sex workers must work out of a licensed brothel, be regularly screened for sexually transmitted diseases, and undergo extensive background checks.

  In the 1980s, when Hof and his friends frequented the brothels, they were dingy, sad places—often a trailer in the desert where women were expected to perform any sex act the customer wanted for whatever price the house set. The women weren’t allowed to leave for days at a time.

  In 1993, Hof bought the Moonlite brothel in a small town just outside Carson City and decided to approach sex work the same way he sold time-shares. He abolished set prices and let the women choose what services they wanted to provide and to whom. He set up the business so every woman at the brothel worked as an independent contractor who could come and go as she pleased* and negotiate the terms of each transaction herself. This gave her more autonomy and an incentive to hustle and ask for more money. By the time he died, Hof had bought six other brothels in Nevada; I visited four of them.

  In many ways, the brothel is like any other workplace. There are weekly staff meetings (in a departure from the tradition at most companies, the women often wear outlandish hats and drink tea), access to financial advisers, performance bonuses, and even corporate housing (Hof owned a local apartment buil
ding where many of the staff live). The Moonlite BunnyRanch, his best-known brothel, was even featured in a racy reality TV show called Cathouse.

  But where Hof provided value was by reducing risk, for both buyers and sellers of sex.

  Supply

  During my time in Nevada, I met dozens of sex workers, and each one does the work for a different reason. Some of the stories are heartbreaking; others simply describe a woman who likes her job and the money it provides. I met women with MBAs and PhDs. And in all my years studying economics and finance, I’ve never met a shrewder businessperson than Shelby Starr.

  Starr was one of the top earners in Hof’s seven brothels.* She is in her midforties, curvaceous, with flowing blonde hair, and speaks in a warm, raspy Texas accent. Starr is married with three children, and except for her unusual career, she lives a typical life. She works all day at the brothel and comes home to her family most nights. We met in Starr’s bedroom to talk about her business.

  Before starting at the brothel, Starr lived a double life: marketing executive by day and exotic dancer on the side. Or it might be more accurate to say that she was a high-paid exotic dancer “on the conference circuit” who had a corporate job on the side. “There’s a conference circuit for strippers?” I asked.

  There isn’t an official circuit, Starr explained, but she noticed that she earned more dancing when certain conferences were in town. She researched the locations of different conferences—tech paid best—and built relationships with strip clubs all over the country so she could follow the most lucrative events to different cities.

  Not surprisingly, Starr earned more by dancing than at her corporate gig. She admitted that she only kept her day job to avoid the stigma associated with being an exotic dancer, in part because she comes from a religious family. A traditional job also made it easier to live in a small community and raise children. For more than fifteen years she quietly pursued both careers. But Starr acknowledged that her corporate/Flashdance lifestyle “was pretty obvious. I mean, with the platinum hair, fake tan, and boobs, I wasn’t fooling anyone.”