[I]f the game of order-versus-chance is to continue as a game, order must not win. As prediction and control increase, so, in proportion, the game ceases to be worth the candle. We look for a new game with an uncertain result.
– Alan Watts
In a previous contribution I noted that the boom in retail trading via gamified apps is a another sign of modern-day financial bubbles. The recent GameStop saga has become its poster child, accompanied by media hype. Like the high-frequency flow of trading that lifted GameStop’s stock into a short squeeze, a flurry of articles and comments reporting on it piled up. It became a game of quick draw and jumping to conclusions―often wrong ones, as others have shared on these pages.
There is therefore something to say about following Daniel Kahneman’s advice to “think slow” about this saga and its aftermath. Despite overwhelming media attention, a number of important issues remain unlit. There is thus a need to highlight key conclusions and other insights. They yield a broader message―especially aimed at policymakers―on how to fix our broken markets.
My list below is, as always, informed by the Market Mind Hypothesis (MMH) which offers a powerful framework to analyse such events. It particularly criticises mechanical economics as the culprit for our economic predicament. I have also been guided by Charlie Munger’s dictum “show me the incentives and I’ll tell you the outcome”:
- Investing: Automation makes investing seem effortless. But if investors are not incentivised to learn about investing, its outcome will not be understood and will frequently disappoint. Einstein advised to make things “as simple as possible, but not simpler”. The latter was a warning, one not heeded by mechanical economics. Mechanical economics has made investing easier and simpler―for example, via exchange traded funds (ETFs), smart-phone based trading apps and via cheap margin debt. But mechanical approaches have also made markets more complex, for example via derivatives, algorithms and distortionary monetary policies, among others. There is now growing tension between these two developments. For instance, while information asymmetry has always been a problem in markets―institutional “smart money” invariably has the edge―the inequality in investor education is a big problem. In the case of GameStop, for example, even if the instigators were experienced and well-informed traders, the majority of followers―the proverbial “greater fools”―were not.
- Business models: Retail investors are not the true customers of Robinhood and other commission-less trading venues. High-Frequency-Trading (HFT) market makers―like Citadel and Virtu―are the heart of the Robinhood business model. The flow of orders from retail investors are the product that Robinhood offers for sale to HFT firms, which then make money from such flows in a mechanised, riskless manner. Although HFT firms deny front-running, executing personal orders via free trading comes at a hidden cost, similar to sharing personal data via free services on the internet. In short, Robinhood’s slogan to “democratise investing” is as hollow as Google’s infamous “do no evil”.
- Control: Worrying linkages between family offices, hedge funds, market makers, and trading platforms have been revealed by GameStop. Crucial plumbing and liquidity of financial markets is increasingly dominated by a cabal of unlisted private entities. In MMH’s terms, Mr. Market’s body receives unsupervised treatment―including organ shut-downs (i.e., arbitrary trading outages) and shock therapy (self-serving bail-outs), often obscured from public vision.
- Conflicts: In analysing criticism of short-sellers and the Reddit retail crowd, many commentators have pointed to the numerous instances of conflicts-of-interest. One that stands out is the planned “investigation” by US Treasury Secretary Janet Yellen, which is awkward for two reasons. First, as former Fed Chair she is partly responsible for creating the easy-money conditions that over-greased the market-trading machine. Second, as widely reported, after retiring Yellen got paid roughly $1mln by Citadel for guest speeches.
- Manipulation: According to securities laws market manipulation occurs when an “artificial price” is created or maintained in a security. No doubt regulators will investigate whether manipulation took place in the GameStop case. However, such laws do not apply to central bankers. Yet appearances matter. Central banks set bad examples by buying distressed assets, bailing out bankers, setting negative interest rates and positive creating wealth effects for the already rich, all of which fuels anger and frustration among the 99%.
- Whatever-it-takes: A significant number of the Reddit herd appears to have been motivated by factors beyond profit maximisation, including revenge. There is a genuine risk that attention-induced trading turns systematic, particularly now that social media chats are full of other short-squeeze candidates. Before long, radicalized traders may find ways to sow financial stress or even create a bank run. This is hardly a fruitful direction of travel.
MMH asks a simple question: “what happens when you treat the market, which is a collective extension of conscious minds, as an automaton?” Through this lens the GameStop saga is another symptom of serious maladies affecting our economic mind-body. Specifically, MMH emphasises that investing involves practical dualism—a mental “thinking” side (like trading decisions) and a physical “action” side (e.g., trade execution). Those incentivised to facilitate the latter don’t care much about the former. Making trading more “efficient” doesn’t necessarily improve investors’ understanding.
The ongoing market mechanisation―turning Mr Market into a ‘gamed’ machine―is compounding unintended consequences. There are many measures policy makers can take in the short-term to address the issues raised above.
One improvement would be to separate financial firms and their regulators via much stricter rules to prevent lobbying, revolving-door appointments, post-retirement speeches/endorsements, and other conflicts-of-interest. Longer term, as per MMH, economics needs to revise its flawed paradigm that justifies and motivates self-reinforcing mechanisation. Genuine investor education is required to improve investment outcomes. And that requires more than hearings and investigations conducted by conflicted parties.