Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Insanity

The True Dangers of GameStop (GME) and Robinhood

The GameStop (GME) and Robinhood frenzy in January proves Benjamin Graham was right about the markets and human nature. Graham, the legendary value investment guru known as Warren Buffett’s teacher, famously said, “Mr. Market is insane.”

The GameStop lunacy proves that Graham was both a superb judge of human nature and a prophet. Mr. Market is not only insane, new technologies are making him crazier.

In 2021, Mr. Market paid $17.25 for GameStop Corp (NYSE: GME) on 4 January and $347.51 on 27 January. By 4 February 2021, GameStop’s share price had fallen to $73.43. Incredibly, a day later GME fell to $63.77 a share on 5 February 2021, GameStop hit even higher prices. It was trading at $379.71 on 29 Friday 2021 and there are claims Mr. Market paid over $450 for GME.

I consider GameStop a dying company because it reported a -$63 million quarterly operating loss on 31 October 2021. Moreover, GameStop has only reported operating income once in the past six quarters. GameStop reported $75 million in operating income on 31 January 2020.

Moreover, Stockrow estimates GameStop’s revenue growth shrank for six straight quarters. Thus, GameStop is a money-losing company with a shrinking business, yet Mr. Market paid $347.51 for it.

What GameStop can Teach us about our markets?

GameStop’s stock price exploded because we gave ordinary investors access to a dangerous new technology.

The dangerous new technology is fast-stock trading apps such as Robinhood and the Cash App. Such stock trading apps are not new, but Robinhood added a disruptive twist to them.

Robinhood offers commission-free trading to small traders. Instead, Robinhood makes money from payments from order flow, Investopedia speculates.

A payment form order flow is a kickback from a large institutional investor such as an investment bank or a hedge fund. To explain, the institutional investor pays Robinhood a fee for directing trades to its platform.

 In exchange for Robinhood’s trades, the institutional investor can harvest enormous amounts of data about the trades. The hope is that the data will give the investor and its algorithms new insights into market behavior.

The danger from this practice is that makes trading easy, cheap, quick, and painless for ordinary people. For instance, Robinhood can afford to sell investors tiny pieces of a stock. Hence, you could buy $5 worth of Amazon (AMZN) through Robinhood.

The Dangers of Gamification

The low prices and fast-trading drive the gamification of the stock market. People come to view the stock market as a game or worse, a casino.

Consequently, podcast guru Professor Scott Galloway believes many Robinhood users are sports bettors looking for an alternative to place wagers on football and horse races. Galloway thinks Robinhood is addictive and preys on lonely young people.

The danger is that many people are now treating the stock market like a slot machine. For most people slot machines are fun and harmless, you drop a few dollars into the one-armed bandits for quick amusement.

However, slot machines mesmerize chronic gamblers who get hooked on the excitement of fast riches. Thus, the chronic gambler puts all of her money in the slot machine and goes broke. Apps, such as Robinhood, have a similar effect on some people.

Galloway believes the havoc Robinhood could wreak on our society and economy could rival the harm social media such as Twitter (TWTR) and Facebook (FB) cause. Critics already blame Robinhood for the suicide of Alexander E. Kearns, a college student. Kearns threw himself in front of a train after seeing a negative balance of -$703,165 on his Robinhood account.

The Illusion of Control

I think one of the greatest dangers of apps such as Robinhood is the illusion of control. Similarly, to a video game, Robinhood gives users a false sense of control over markets and money. Any young man can become the next Master of the Universe by clicking on Robinhood.

In reality, news reports show investors are at the complete mercy of Robinhood’s management. For instance, Robinhood suspended or restricted trading of several hot stocks, including GameStop (GME) and AMC (NSYE: AMC) on 28 January 2021. News reports claim Robinhood froze many traders out of their accounts.

These claims scare me because history shows runs and stock market crashes begin when investors realize they have no control. For instance, people ran to brokers to take all their money out of stocks in October 1929 when they learned stocks could lose value.

Where were the Regulators?

Frighteningly, Robinhood faced a classic run in the last week of January 2021.

The New York Times speculates Robinhood ran low on cash and sought a $1 billion emergency infusion from investors. The app’s managers also used emergency lines of credit of $500 million to $600 million from six banks to cover expenses.

Business of Apps estimates Robinhood had 13 million users in 2020. Anecdotal evidence shows many of those users are ordinary people with limited incomes.

Therefore, a major brokerage could not cover its trades. That could trigger a market cash or a panic that wipes out many investors’ incomes, and it could violate federal regulations.

How did regulators such as the Securities and Exchange Commission (SEC), Federal Reserve, and US Department of the Treasury allow Robinhood to operate without adequate capital? Similarly, regulators allowed millions of Americans to invest through that brokerage.

Furthermore, why did the SEC allow Robinhood to offer low-cost trades in the first place? Robinhood was trying to disrupt and reorganize the stock market tens of millions of Americans rely on for retirement and regulators did nothing.

Back to the 1920s

It sounds as if we have returned to the unregulated stock market of the late 1920s. In the 1920s, before the New Deal, banks and major investors self-regulated the markets.

The self-regulated market led to the Stock Market Crash of 1929 and helped trigger the Great Depression. Yet it sounds if hedge funds and app designers are regulating the stock markets.

Congress and the Biden Administration need to inspect stock market regulation. The GameStop bubble shows America’s markets are out of control as they were back in the 1920s.

What Robinhood and Game Stop can teach us America’s sick economy

Beyond the lack of regulation, Robinhood and the GameStop (GME) offer some frightening insights into America’s sick economy.

First, our leaders in government, Wall Street, and the media do not care when ordinary people get hurt. For instance, nobody except a few leftists such as Galloway criticized Robinhood after Kearns’ death.

However, CNBC and the rest of the media flew into a panic when Robinhood’s speculation threatened to bring down hedge funds. Similarly, Wall Street only cracked down on Robinhood when its excesses threatened large institutional investors. No hedge fund took action when Robinhood was disrupting ordinary people’s lives.

Second, I think many people are speculating through Robinhood and similar apps because they have few alternatives. People are playing the stock market because their incomes are low and unreliable.

For instance, the St. Louis Federal Reserve estimates 39% of Americans admitted they could not cover a $400 emergency expense in 2019. I think the percentage of people without $400 is now higher because of the pandemic.

Such lack of income drives people to speculate and take irrational risks to make money. Unfortunately, political leaders and pundits respond to such stories by lecturing ordinary people about the necessity of saving money and steady gains.

Such lectures are excellent advice for people with job security and rising incomes. However, for those trapped in the gig economy, young people bogged down by student debt, and people who change jobs often, such advice is useless.

Instead, speculation with extra income is a rational move for people in desperate straights. A 30-year-old Uber driver or teacher who uses his stimulus money to speculate on Robinhood is making a smart move. The $600 or $1,200 check will add little to his savings, but Robinhood speculating could make him $10,000 or more.

Therefore, Robinhood profits from income inequality and the desperation of a shrinking middle class. Hence, income inequality and government policy that favors the rich over everybody else empowers tools such as Robinhood.

Third, the GameStop bubble which reportedly began on the Wall Street Bets Reddit feed shows a dangerous new trend in outsourcing. To explain, investment banks will stop employing high-paid analysts because it is cheaper to build an algorithm that analyzes Reddit or Robinhood.

Therefore, many investment bankers and Harvard Business School grads will find themselves in search of new jobs. Technological unemployment will grow as the decentralized economy and the platforms that empower it spread.

Fourth, the greatest danger of digital tools such as Robinhood is the empowerment of ordinary people. Robinhood disrupted the stock market with 13 million users. What happens when a blockchain or Fintech app gets 100 million or a billion users?

We’re living with the effects of social media on culture. What happens when Fintech becomes as disruptive and as pervasive as Facebook? For instance, what happens when Grandma uses her Social Security payment to speculate through Robinhood?

The GameStop bubble shows Americans need to take a hard look at their economy. Technology is taking Mr. Market to some dangerous places and giving him frightening new power over our lives. If we don’t limit Mr. Market’s access to new technologies, we all could suffer.

a homescontents