How to lose money running a casino

There is a popular belief that running a casino must be the easiest business in the world. After all, the games are rigged in your favor. Not secretly, not dishonestly, but mathematically, openly, and with great precision.

Take roulette. In its European form, there is a single zero. In the American version, there are two of them. Some places these days even have tables with three zeros, which is a bit like adding a second lock to a door that was already keeping people out. The principle is simple enough. The payouts remain based on odds that assume fewer losing numbers than actually exist. To put it plainly: if your number comes up on a wheel with 39 numbers including three zeros, you are paid out at odds of 35 to 1. The house pockets the difference on every spin.

The extra zero or zeros belong entirely to the house. Over time, this failure to pay out the correct odds ensures that the casino collects a steady percentage of all wagers, and that if you play long enough, it will win all your money.

The same is true of every other game on the floor. Blackjack and similar games carry small built-in advantages. Slot machines go even further and leave nothing to chance. They are programmed to return a fixed proportion of what is inserted, with the remainder kept by the operator. The percentages vary, but the direction never does.

Given all this, you might reasonably conclude that a casino is a money-printing machine. And yet it is perfectly possible to lose enormous amounts of money running one.

To understand how, you have to step away from the gaming tables and look at the business behind them.

The first difficulty is timing. One of the most instructive cases involved the Trump Taj Mahal, which opened in Atlantic City, New Jersey in 1990, financed with large amounts of borrowed money at high interest rates. It opened just in time for a recession. When the economy slows, people do not stop gambling entirely, but they gamble less, travel less, and spend more carefully. A casino that expects a steady flow of confident customers suddenly finds itself dealing with hesitant ones. The mathematical advantage remains intact, but volume matters, and volume has dropped.

The second difficulty is debt, and here you run into a term that was everywhere in the 1980s: the junk bond.

A junk bond is simply a bond issued by a company considered too risky for investment-grade status. Because the lender is taking a bigger chance of not being repaid, the borrower has to offer a higher interest rate to attract investors. Financiers like Michael Milken made their names popularizing these high-yield instruments to fund large, ambitious projects. For a casino developer, the appeal was obvious. Instead of waiting years to accumulate capital, you could borrow enormous sums immediately, build something spectacular, and bet that future revenues would cover the cost. The interest rates seemed manageable as long as the money kept flowing.

It was, in effect, a bet. Only not at the gaming tables, but on Wall Street.

As long as revenues met projections, the model held together, but if they fell even slightly short, the interest payments did not. They were fixed, and relentless.

The Taj Mahal was a textbook case of exactly this kind of thinking. Trump financed the project with junk bonds carrying an interest rate of 14 percent on borrowings of $675 million, which meant the casino had to generate extraordinary revenues from its first day of operation simply to service the debt.

A financial analyst named Marvin Roffman said publicly before the opening that the numbers did not add up, and that the property could not possibly earn enough to cover its obligations–so Trump had him fired.

A little over a year after the grand opening, the Taj Mahal filed for bankruptcy, and Roffman collected $750,000 in a wrongful termination settlement. He later also settled a defamation suit, on undisclosed terms. It is one of the best known illustrations in modern business history of what happens when the obligation to service debt is larger than the business can realistically bear, regardless of how well the gaming tables perform.

The third difficulty is competition. Atlantic City expanded fast through the 1980s, with multiple casinos opening or enlarging at the same time, each one counting on a growing market. The market did not grow fast enough to keep up. Meanwhile, new forms of gambling were appearing across the country. Riverboat casinos and Native American casinos began drawing customers who might otherwise have made the trip to the New Jersey shore.

The result was a thinner crowd spread across more tables.

Then there is the question of who was actually showing up. Atlantic City built its model heavily around day-trippers from New York and Philadelphia. Buses would arrive from both cities, delivering visitors who would spend a few hours gambling before heading home. Most of these customers were not high rollers. Many had been enticed with free transportation and a roll of quarters to get them started. They kept a close eye on their losses, skipped the hotel rooms, ignored the shows, and passed on the expensive steaks and cocktails. Like Julius Caesar invading Britain, they arrived with great confidence, found the returns disappointing, and were gone before anyone noticed they had been there.

From a certain angle, they were ideal customers. From a financial standpoint, they were less useful than they looked.

This brings us to the sharpest contrast of the era: Las Vegas. Around the same period, Nevada casinos were reinventing themselves. Gambling became one element inside a much larger resort experience. Visitors might gamble, but they also spent money on entertainment, dining, shopping, and conventions. They stayed for days, not hours. Their spending was broad and far less dependent on whether they won or lost at the tables.

Atlantic City never made that leap. If a visitor did not gamble, there was usually nothing else pulling money out of his pocket. If he gambled cautiously, the house advantage over him, though real, was limited by the modest amounts he was willing to lose. The Strip in Las Vegas was selling an experience. The Boardwalk was selling a transaction,and frankly, there was not much worth seeing in Atlantic City.

All of this might have been survivable with conservative financing, but layered on top of heavy debt at high interest rates, it became a slow-motion disaster. A highly leveraged casino is like a tall building on a narrow foundation. Everything looks fine until the ground shifts slightly, and then it does not take much to bring it down.

The recession shifted the ground. Competition shifted it further. The day-tripper model was the foundation that was never quite wide enough. And the debt ensured that none of these problems could be absorbed without consequence.

So the original question answers itself. The games do overwhelmingly favor the house, but the business that owns the house is subject to forces that have nothing to do with the spin of a wheel or the turn of a card.

The house always wins, people say, which is true enough if you are talking about the table in front of you. The house on the balance sheet is playing an entirely different game, and those odds are almost as hard to beat.

So no hidden scandals or dramatic reversals of fortune required. Just timing, debt, a crowded market, and a busload of visitors who came for the free quarters and were home in time for supper.

That is how you go broke running a casino. Easy, really.