The Joker was right about one thing…introduce a bit of chaos and everyone loses their mind. And that’s just what happened with the fervor created by a rogue group of investors on Reddit as they pushed the price of GameStop and other nearly defunct companies higher and higher. Regulators usually have no idea what to do with themselves during a black swan situation like this, but they know they need to do something. And it doesn’t matter what the unintended consequences might be. This rally has given them the perfect opportunity to crack down on Wall Street without actually looking at what caused the issues in the first place.
I am reminded of Frédéric Bastiat’s parable of the broken window. It goes something like this: a boy breaks a window at his father’s shop. His father hires the town glazier to replace the broken plane. The glazier than spends the money he earns on himself or his business, thus stimulating the economy. The townspeople decide that the boy has done the community a huge service and everyone is better off as a result of this happy accident.
However, Bastiat points out that this is a fallacy. By forcing his father to pay for the window, the boy has reduced his father’s disposable income. His father will not be able to purchase new shoes he may have been wanting or invest in his own business; thus, other industries will experience losses. The time he spends dealing with the broken window could have been put to better, more productive use. Furthermore, replacing the window is a maintenance cost, not a purchase of new goods, and maintenance does not stimulate production.
This parable has typically been used to discredit the idea that going to war stimulates a country’s economy. But I think this parable perfectly highlights the general tendency of bureaucrats and policymakers toward implementing sweeping reforms without looking at the unintended consequences. Sound bites and feel-good-isms, not full analyses from all angles, rule the day.
For instance, there was a time in 2008 when regulators in the United States banned naked short selling without considering the unintended consequences. There was also a media war against futures trading, derivatives and securities (all legitimate and very important market mechanisms that actually help to lower volatility and spread wealth) without any acknowledgement of the unintended consequences. In other words, these regulations broke a lot of windows. But some people on Wall Street found a way to profit from these broken windows. This doesn’t mean the regulations weren’t damaging. But the regulators can see only those who benefited. Meanwhile, there has been very little mention of the continued unintended consequences of maintaining low interest rates, the real culprit of all these problems. (After all, it was zero-interest rates along with the Community Reinvestment Act, which meant everyone with a pulse could buy a house in the first place, that made the mortgage-backed securities so toxic.)
Again now, Wall Street regulators want to get involved over the Reddit/GameStop/AMC hype. Blame Wall Street, as usual, for treating the stock market as a personal casino and for the hubris that has ensued as the little guy suffers.
But what do you expect with near-negative interest rates? That hubris is the result of Band-Aid after Band-Aid after Band-Aid. Whether you call it ZIRP (zero interest rate policy), QE (quantitative easing) 1/2/3, bailouts, stimulus, or some other such name, a rose is still a rose.
Can the Markets Rein in Wall Street?
And now a legitimate market solution has presented itself to combat the old boys’ club of Wall Street. And this solution is doing something Elizabeth Warren had not been able to do…hold Wall Street accountable. This is partly because Warren never understood the problem. The problem was the regulation itself.
Of course, there will be plenty of concern in Washington and at the SEC (Securities and Exchange Commission) about what happened with GameStop, AMC, and others, and the busybodies will want to get involved. The problem when legislators get involved, though, is that they don’t understand or are not honest about the full picture. For now, regulators like Warren and Alexandria Ocasio-Cortez seem to be on the side of the small investor, criticizing the Robinhood app after it banned them from buying stock.
Online trading forums, on the other hand—like those at Reddit—allow smaller, amateur investors a seat at the table. This is the democratization of finance at its finest.
As this unfolded, I was instantly reminded of Thomas Friedman’s electronic herd metaphor:
The electronic herd cuts no one any slack….The herd is not infallible. It makes mistakes too. It overreacts and it overshoots. But if your fundamentals are basically sound, the herd will eventually recognize this and come back. The herd is never stupid for too long. In the end, it always responds to good governance and good economic management.
We also saw the herd in action after Trump/Twitter/Parler debacle. Both Twitter and Facebook lost billions in market value overnight.
The move toward decentralization and democratization of technology and finance is the shining lifeboat in the storm of bureaucratic chaos. And forums like Reddit are our Galt’s Gulches. Regulating these forums could have huge unintended consequences. But hey, if things go sour, they could always just hire a glazier to patch things up.
