The Game Stops Here

by | February 1, 2021

Few topics have dominated the financial news lately like the GameStop saga that has unfolded over the past week. And few topics have been covered as poorly, in the mainstream and financial press, as well as on social media. In what follows, we highlight what GameStop means and what it does not.

First, the GameStop story is, thus far, only about a few stocks, rather than a market-wide phenomenon. That matters, because we are not yet confronted with broad market instability or an economy-wide misallocation of capital. That is important because it will shape the discussion about what regulatory action, if any, is necessary.

Second, there is a lot of nonsense in the commentary. Many observers impart a moralizing tone, castigating hedge fund shorting while lauding the ‘democracy of finance’. Both judgements are wrong.

For instance, why are ‘value’ investors who buy cheap stocks heroes, but those who sell expensive stocks pariahs? In both cases, their actions nudge stocks toward their fundamental equilibrium. Surely both are good financially and economically.

As for ‘economic democracy’ or ‘financial democracy’, well, they are oxymorons. Democracy rests on the principle of one adult, one vote, whereas capitalism is based on the principle of one dollar, one vote. Capitalism and democracy sit uneasily alongside one another, but market-based systems of resource allocation should never be confused with, nor aspire to be, ‘democratic’. Allocating resources democratically is inimical to market economies, in extremis it is communist.

Third, a common misperception of the GameStop phenomenon is conveyed, unsurprisingly, by the name of the key trading platform involved, Robinhood. The implicit reference is that of a mechanism to steal from the rich and give to the poor.

Yet the myth of Robin Hood, the legendary figure, is not the underlying principle of the Robinhood user. Initiating a short squeeze is probably not theft (we’ll return to that point shortly) and for certain no altruism is involved. We have yet to hear of any GameStop investors who have profited from the affair and then donated their windfall to the less fortunate.

Rather, greed and vengeance are more apt descriptions for what is going on. And, to borrow from Gordon Gekko, ‘greed is good’, at least when it comes to economic decision-making. More politely, economists refer to it as ‘self-interest’, but that is semantic distinction without a difference. And, if the chat boards are anything to go by, some GameStop buyers were motivated by vengeance, a desire to extract pain from Wall Street.

Fourth, there is nothing wrong with hedge funds (or anyone else) been squeezed out of their shorts. It is a regular occurrence and rarely draws much attention. But market manipulation is another matter. To the extent that the actions of GameStop stock buyers were organized and coordinated, they could have crossed the line into illegal market manipulation. Indeed, the US Securities Exchange Act defines market manipulation as ‘transactions which create an artificial price or maintain an artificial price for a tradable security’.

Legally, there is much to unpack and almost certainly lawyers and regulators will scrutinize what has just happened for any wrongdoing. But one thing is clear: Manipulating markets is a crime irrespective of whether the manipulators are buying or selling.

It is, however, also perfectly acceptable to convey legitimate market information (as opposed to rumor or falsehoods) to others, including on social media platforms. Reddit users did nothing wrong in alerting others that large short positions existed in GameStop and other securities. No one may dispute the legitimate use of any medium, such as Reddit, to convey factual information on which others may act in financial markets.

Fifth, there is considerable hypocrisy from various commentators about the ethics of short-selling. Those who take pleasure in the short squeeze of hedge funds apparently have forgotten how the media heralded ‘The Big Short’ as the voice of sanity and virtue during the global financial crisis. How quickly attitudes toward shorting have changed.

Sixth, the GameStop episode has revealed how the financial services brokerage industry has changed. Information today flows freely and instantaneously to any willing participant in markets. Valuable information is no longer the privilege of the professionals. Low or no commission trading on platforms, like Robinhood, create vast new opportunities for market participation. Some users may have been tantalized by moral tales of financial pitchforks skewering the lords of finance, but vengeance is unlikely to be the sole or even primary motivation for most of those now gaining direct access to the world of finance.

But with access comes responsibility, if not to others then to one’s own personal finances. There is precious little evidence that trading, per se, creates opportunities for sustainable wealth enhancement. Free market access to the uninitiated is akin to handing over the car keys to those with no experience behind the wheel. Accidents happen in finance as much as anywhere else.

If no other lessons are drawn from this experience, the financial services industry and its regulators should promote and offer early and continuing personal finance education. Savings, investment and diversification are sound ways to manage personal finances, but acquiring those skills and knowledge ought to precede, not follow, access to the instruments of finance.

The GameStop episode also risks creating the false belief that trading is a legitimate way to make money. That is unlikely. For every story of a GameStop windfall there are many untold ones of losses. Short-term trading not only poses risks to the health of one’s financial portfolio. It may be addictive as well, an observation we make based on experience of family and friends.

Lastly, the events of the last week exposed Robinhood investors to a risk they had not known, one that lurked out of sight, deep in the plumbing of the financial system. Specifically, as the price volatility of a security jumps, the clearing houses that facilitate the transfer of cash for stocks require more collateral from the broker to cover their risk of settling both sides of the trade.

In the case of GameStop and other stocks that were caught up in last week’s frenzy, the required excess collateral for Robinhood put at risk its financial standing. Robinhood was therefore forced to curtail trading in those stocks, exposing an army of retail buyers to significant losses if they are unable to sell their shares before the price collapses.

In short, GameStop buyers may have felt they ran only price risk, when in fact they also faced illiquidity risk. Yet the revelation that markets, even for stocks, can become illiquid may ultimately send a powerful and welcome message—one of prudence and ‘buyer beware’ that tempers future excesses. The plumbing of finance may not be glamorous, but it exists to facilitate market functioning. It may also play a beneficial role as a ’sand in the wheels’ mechanism, reminding traders of the risks inherent in wild stock rides.

GameStop offers useful lessons. But they are not about altruism. Nor are they about oxymoronic notions of financial democracy. GameStop was mostly about the usual suspects—greed and excessive positioning. Few lessons may be better than ‘buyer and seller beware’. Trading is risky business. Awareness requires knowledge. With greater access to markets, the industry and its watchdogs ought to redouble the access for all to sound financial education.

With greater knowledge, the game may not stop, but it might turn out better.

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the U.S. Secretary of Defense. He is a member of the board of directors of Franklin Resources, Inc. (Franklin Templeton), a member of the Council on Foreign Relations, Chairman of the Advisory Board of Project Syndicate and a board member of the American Alpine Club. Friedman is a regular contributor to a range of newspapers and thought leadership groups and is also the author of Babu’s Bindi, and The Big Thing, both children’s books. He is an avid mountaineer and rock climber and led the first major climb to raise money for charity through an ascent of Mt. McKinley. Friedman holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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