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Brief #36 – Technology

GameStop, Reddit and Free Trading Apps A Threat to Economic Recovery?

By Charles A. Rubin

February 16, 2021

Policy Summary

The drama surrounding the wild trading and social media fueled speculation in the shares of stocks GameStop, AMC Entertainment, Bed Bath & and Beyond, Blackberry and other underperforming companies has thrust Wall Street near the top of a crowded list of issues that President Joe Biden’s regulatory team needs to tackle early in its term.

The wild fluctuations in these stocks which played out in the waning days of January revealed a new dynamic of Reddit subgroups, trading apps with no business model for profit and sophisticated social media personalities. There is excitement that the individual investor will be able to reap the benefits that had been only available to savvy and secretive Wall Street types. There is equal concern that we are creating bubbles that will seriously damage our economy when it can least sustain any more shocks.

As the Biden administration begins its work, free or low cost stock trading applications such as RobinHood, M1 Finance, ETrade and Acorns have made it simple for casual investors to gain easy access to markets as well as offering them financing and trading advice. They are proving a formidable counterweight to institutional investors and hedge funds but may perhaps introduce an element of instability to already volatile markets that were under stress due to pandemic related economic uncertainty.

Analysis

It all started with Reddit’s WallStreetBets forum where participants egged each other on to create a buying frenzy for several stocks that would not have attracted any attention otherwise. At the same time, several Wall Street Hedge funds were shorting those same stocks, meaning they were wagering that those same stocks would go down in value. Fortunes were made and lost in days to both institutional hedge funds and newly minted day traders. In one measure of the insanity of it all, GameStop’s stock soared 1,640% in 10 days

In many ways, this market blip was similar to the conditions that led to the Wall Street collapse of 2008 where financial instruments based on mortgages which were fundamentally worthless began to unravel. The instabilities in the January 2021 market were caused by two factors; irrational investors who were overvaluing stocks in companies that had not substantially changed their business outlooks and stock trading apps that were selectively halting trading in these stocks. The target company stock prices abruptly turned down when the trading app Robinhood and other brokerage firms announced a slew of restrictions on the trading of a handful of stocks that had been spiking.

This behavior by online trading platforms hardly represents a free market. It is clear that regulators need to monitor how these applications operate. Last year, Robinhood agreed to pay $65 to settle SEC charges of providing misleading or incomplete information on its dealings with the firms that actually handled their trades. It is a complicated business model and more scrutiny and transparency is warranted.

While many applaud the wide availability of free trading platforms and traders enjoy the gamification of the investing, markets are dependent on rational trading. A stock should only be worth its true value in the marketplace based on what it is producing or its potential to produce. The Biden administration would be wise to take a close look at the regulations governing the stock markets for both Wall Street and the lay investor.

Engagement Resources

  1. The Office of the Investor Advocate at the Security and Exchange Commission works to ensure that the needs of investors are considered as decisions are made at the SEC.
  2. The American Institute of Economic Research Founded in 1933 (AIER) is one of the oldest and most respected nonpartisan economic research and advocacy organizations in the country.
  3. FinTechPolicy.org serves as a hub for collating and analyzing global regulatory developments in financial technology. They are supported by a range of academic, nonprofit and market leaders and seek to provide an interactive forum for understanding fintech and the emerging rules and regulations devised to address them.
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