Pavlo Gonchar/SOPA Images/Sipa USA via AP Images
Retail investor frenzy into stocks like GameStop and AMC Theatres is indicative of a broader disconnect in the markets between trading and fundamental value.
This morning, the House Financial Services Committee will hear from the CEOs of Reddit, Robinhood, Melvin Capital Management, and Citadel LLC, along with Keith Gill, star of the r/WallStreetBets message board (he’s known as “@TheRoaringKitty” on Twitter; I’d put his WallStreetBets handle here but it’s unprintable in our demure publication). The hearing is intended to discuss the collision of short selling, social media, and retail investor market speculation. But I’m actually struggling to figure out where this hearing is supposed to go, relative to what we need to actually uncover about our financial markets.
I have written that the retail investor frenzy into stocks like GameStop and AMC Theatres is indicative of a broader disconnect in the markets between trading and fundamental value. The “tricks” Redditors use to temporarily pump up certain stock prices—really less tricks than just a mass determination to speculate—have been used since time immemorial, and are continuing right now by those investors we’ve decided to call “sophisticated.” The rise of SPACs, shell companies with no products or sales built simply to allow companies to go public without having to subject their books to scrutiny, is an excellent and disturbing example of this over-financialization. (A SPAC filed for trading yesterday with the actual name Just Another Acquisition Corporation. Even SPACs are bored with the insanity of SPACs.)
But there are so many other examples. See, for instance, what is now a fairly common trend of publicly traded stocks with similar names to hot companies blowing up in price. ClubHouse Media Group, a marketing company, saw its price rise 1,000 percent after investors mistook it for Clubhouse, the new privately held social media app. Similar cases of mistaken identity have occurred with Zoom Technologies, which is not the meeting software, and Nikola, an electric-car company that happens to share its namesake with Tesla but has no association with the automaker. Speaking of SPACs, a new one named Ark Global Acquisition seems to have deliberately named itself similarly to a superstar investment fund, ARK Investment Management, just to confuse people.
This keeps happening because nothing really matters in a state of market mania.
See also the triumphant return of junk bonds, a leftover from the 1980s that has re-emerged with a vengeance in the pandemic era’s increased appetite for corporate debt. Some of the lowest investment-grade companies have been able to scoop up billions of dollars in borrowing, with investors ignoring default risk. Junk bonds are often used to make leveraged buyouts, allowing private equity firms to suck out value and destroy companies and abandon their workers. Cheap and plentiful debt can lead to real-world problems.
This tracks with a ramp-up in speculation across asset classes. Over $58 billion was invested into mutual and exchange-traded funds in just one week earlier in February, a new record. Commodities like silver have seen a spike. Bitcoin hit $50,000 on Tuesday. Even worthless instruments like Dogecoin, a joke cryptocurrency modeled on a dog with a misspelling problem, has surged, mostly after rich-guy tweeting.
It’s true that earnings reports have shown large companies holding on through the pandemic, and the combination of a big retail sales boost in January (thanks in part to $600 relief payments) and the expected $1.9 trillion Biden rescue plan has investors extremely optimistic. But that doesn’t explain the rise of, for example, Dogecoin, or the ability of fairly doomed newspaper chain Gannett to secure $1 billion in loans, or, well, a brick-and-mortar video game rental and sales company zooming up and down the stock charts.
Markets of all kinds have gotten way too flush, and the ultimate results are fairly predictable to anyone who has studied boom-and-bust cycles. When the president of the New York Stock Exchange has to come out and say, “The markets are not a casino,” you get the impression that she made the assertion while simultaneously throwing up her arms to hide the craps table in the trading pit.
At least some more thoughtful members of Congress agree. Rep. Ro Khanna (D-CA) released a statement noting that GameStop raised no money from the historic run-up in its stock; the secondary-market trading was pure speculation, disconnected from the initial purpose of public markets (though of course that’s been true for a long time). “This controversy put the over-financialization of Wall Street on the national stage,” Khanna wrote. Rep. Cindy Axne (D-IA), who actually sits on the Financial Services Committee, told me that her preoccupation with the GameStop craziness was asking herself, “‘Why do Americans think the only way they can get ahead is to go into the markets?’ It points to a bigger issue of equity in this country. People are tired of sitting on the sidelines while Wall Street gets richer and richer.”
Markets of all kinds have gotten way too flush, and the ultimate results are fairly predictable to anyone who has studied boom-and-bust cycles.
Of course, joke cryptocurrency owners and high-frequency traders and eleventy-billion SPAC originators aren’t really the focus of the Financial Services hearing, though maybe they should be. What can members of Congress get accomplished when talking about something that is only reflective of more important market trends?
First of all, they can talk about banning unproductive and speculative trading instruments, from the popular options trading method in the Robinhood app to things like naked short selling, where investors trade without ownership of the underlying security. (Short selling can perform a legitimate function; opaque naked shorting does not.) My list of what trading isn’t useful or necessary for an economy to function is long and substantial. We could tax it with a financial-transaction tax or regulate it out of existence. We don’t have to let hedge funds exist, or let private equity firms pillage Main Street businesses.
Redditors investing in GameStop, from all the profiles, by and large seem to have known the risks and treated it as extraneous gambling money. And they were not really the ones moving the stock price; high-end traders were more fundamental. But do Americans really need a Goldman Sachs robo-adviser app when index funds beat these operatic strategies consistently? Do they need Robinhood treating stock trading like Angry Birds? And should fintech companies, which seek to exist outside the regulatory perimeter, be granted the status to mess with people’s savings, whether intentionally or unintentionally? Calling people “Neanderthals,” as former Federal Reserve official Linda Jeng did in Politico, because they don’t think a largely unregulated day-trading app is a particularly useful financial innovation, is just the kind of “anything new is great” mentality that got us into trouble in the subprime mortgage crisis.
The financial-reform group Better Markets has a host of other issues worth addressing, from why Robinhood cut off trading in certain stocks and whether market structure is to blame, to whether brokers are providing “best execution” of trades to app-based traders (and not skimming to maximize profit margins), to the ways in which “momentum trading” has been abused countless times in the past and should be limited in the future. Giving regulators access to a “consolidated audit trail” of all trades so they can identify problems is a reasonable request.
If the hearing focuses on how WallStreetBets members pick a stock, or whether there’s something wrong with “meme trades,” or how ordinary people on a trading app “beat” the market (for a couple of days), we’re in the exact wrong territory. The GameStop short squeeze is important not for what it was but for what it reflected about our capital markets. I hope at least members of Congress recognize that.
