A "black swan" event in the stock market has moved from the financial pages/websites to front-page news on major media because it carries overtones about the proper conduct of capital markets. Here is some informed commentary from an email newsletter by John Authers from Bloomberg (boldface added):
When this week started, I had a long “to do” list of topics to cover.
Difficulties in distributing Covid-19 vaccine and the race against virus mutations;
Inflation risks, and the chances of a bond market “tantrum”;
The dollar and the overwhelming consensus that it is due a further fall;
The chances that post-Brexit Britain might now be a “buy” despite everything;
Fourth-quarter earnings season and what it portends for the economic recovery;
The oil market (the price of Brent crude has trebled in nine months);
The chances for a re-made U.S.-Chinese relationship;
Yet another political crisis in Italy and its implications for the euro.
These are all important issues. If you have thoughts about any of them, drop me a line.
Beyond that, you’ll have to discuss these topics amongst yourselves because I’m writing a fourth newsletter in a row about a small video-game retailer in the U.S., which was worth less than $1 billion at the beginning of last month. And yes, GameStop Corp. really is the most important issue for markets.
... I won’t waste time in recounting what is now a familiar narrative. But to bring you up to date, this is the performance of GameStop’s share price over the last month:
It’s hard to believe this won’t become a pivotal event in the history of finance. Here are some of the biggest questions it raises:
Libertarianism vs Paternalism
This is an eternal debate. Freedom means the freedom to mess things up. But governments have a responsibility to citizens, and companies have a responsibility to clients, to reduce the risks that the actions of some will harm others. Driving is the most popular analogy. Paternalism demands that manufacturers fit cars with seat-belts, but libertarianism permits people to take the risk of not wearing them.
There is a line to be drawn. Within markets, it is best to set a few simple rules, enforce them, and leave everyone as free as possible. That way the invisible hand can work its magic. But if the invisible hand really thinks that GameStop is worth $25 billion, something has gone wrong. The Securities and Exchange Commission is considering what to do, and there is plainly a regulatory issue here. Meanwhile, the decision by Robinhood Markets Inc., the main broker used by the Redditors, not to accept trades in GameStop on Thursday has already prompted class-action lawsuits from clients. For arguments against paternalism, look at the comments below the piece by my colleague Conor Sen arguing that Robinhood did the right thing.
As day traders are the Davids in this drama, up against hedge-fund Goliaths, their supporters in Congress include progressive Democrats such as Representative Alexandria Ocasio-Cortez, and Senator Elizabeth Warren. The politics will be unpredictable. But a few points seem clear:
Regulators must respond with equity. Any suggestion that they are defending hedge funds against retail investors would be disastrous. Anything that clamps down on retail trading will have to be balanced by a serious attempt to stamp out “naked shorts” — the practice of selling a stock you don’t have, which led to the imbroglio at GameStop;
The issue of whether Robinhood and others really engaged in “gamification” — making trading more like a game, and helping to get people addicted to it — needs to be addressed. I think they have a case to answer.
The need to protect people from losing money they cannot afford to lose should remain paramount. Redditors complain it would be unfair to stop them from taking risks that are allowed for hedge funds. There’s a good reason for this, though. Hedge funds are restricted to wealthy people who can afford losses, while others deserve more protection. I am sure that opinion will make me unpopular.
There is no libertarian objection to stopping behavior that endangers others. Libertarians can agree that nobody should be allowed to drive a car when drunk. Distorted markets, and particularly asset bubbles, lead to malinvestment and wasted capital, and ultimately to lost jobs. The Federal Reserve is adamant that it cannot and should not attempt to identify and deflate bubbles before they grow too big. Incidents like this suggest that they need to be more active.
His column continues with thoughts about the Future of Shareholder Capitalism and Accoutability for the Global Financial Crisis. I'm going to blog separately some of his thoughts on Intergenerational Conflict.
Addendum: "This is a good 13-minute video from a Twitch livestream, in which a finance expert, Alexis Goldstein, explains to Rep. Alexandria Ocasio-Cortez (D-NY) how Robinhood makes its money." (via BoingBoing)