What Wall Avenue can and should be taught from the GameStop fiasco
Rafael Henrique | LightRocket | Getty Images
In the past two weeks there has been an astonishing number of allegations about the motives of the main characters in the GameStop drama.
Players include the WallStreetBets forum on Reddit, the Robinhood trading app, long-short hedge funds, politicians, and regulators to name a few.
However, equating this event with the other problems facing our country – pandemic, social unrest, economic despair and political discord – is a false equivalency.
It is an attempt to correct one injustice with another. In short, it’s a canard – bait to draw attention to the real risk of the GameStop Short Squeeze and the associated surge in other stocks with strong short positions.
A problem bigger than Sound Bites
This risk is the threat to the proper functioning of the financial markets.
The United States, and the world in general, have benefited from the discipline of properly regulated and enforced rules governing financial exchanges for centuries.
Companies were able to raise capital to create new business ideas and opportunities for expansion. Savers were able to invest in these companies because they knew there were strict rules for how their capital was handled. Business failures are shown in stock prices that can and will go to zero.
The result? Economic expansion, employment growth and productivity.
In short, properly functioning financial markets improve the quality of life.
If the events of the past few months flare up again and the shares of their failed companies soar 16 times in a month, the benefits of flowing stock markets may forfeit. The capital is not allocated to the companies that need and earn it. Investors and the advisors who serve them will be exposed to investment opportunities unsure of what a security is really worth.
And ultimately, Reddit’s disgruntled subscribers to Wall Street Bets and Twitter Warriors will be looking for tight job opportunities in a weak economy.
Potential risk is not just a matter of valuation or capital allocation. Back office operations that enable stock purchases are emphasized.
It is proof of operational excellence that in less than an instant a buyer is found for every seller on an exchange, and vice versa. There are no “runners” who bring physical certificates to the vaults of different banks. Trade processing takes less than a week. It’s effortless.
There are multiple players and multiple points on the way to clearing a trade at which a breakdown can occur.
This includes clients, prime brokers, market makers, the Depository Trust & Clearing Corporation (DTCC) and margin lenders.
It is not yet clear whether there will be any interruptions in the handling of last week’s trading activities. However, it seems advisable to interrupt the flow, be it through higher margin requirements or trading restrictions, until this answer is known.
Breaking the efficient clearing system is not a risk worth taking.
Asking the real question
Let’s not lose sight of the truth as we go through the Congressional hearings and the public shame that is likely to come.
Whether the Reddit events are idiosyncratic or catalyze a more systemic problem is currently unknown.
However, it is the question that should be answered, rather than the virtue signaling that takes place.
Let’s hope that once the investigation and the books have been completed, market participants and regulators will feel that the right action has been taken in the past week – even if it meant certain parties were not getting everything they wanted (ex . unrestricted trade).
If that is the result, confidence in the financial markets will be maintained, and possibly even strengthened, to the benefit of the markets, the economy, and the majority of those participating in both.