Commentary: Pitchfork Populists v. Wall Street?

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by Richard J. Shinder

 

As a long-time financial services executive, every so often I am called upon by friends and family from other walks of life to comment on a story related to the stock market. Such is the case with the GameStop saga.

Given that few of them are well-versed in the ways of Wall Street, that I hail from an investment banking pedigree and not a securities trading — particularly stock trading — background seems to them a distinction without a difference, and I offer my insights as best as I am able. As such, I’ve given more thought to GameStop than I may have otherwise.

While I am sufficiently conversant with the mechanics of short-selling to describe who did what to whom (and how), that I am not by training a market technician has perhaps made me less prone to the sort of hot takes to which we have all been subjected over the last week. Accordingly, I’ve tried to take a more holistic view of one of the most salient news stories of the new year, one at least the equal of Sen. Sanders’ sartorial choices. In considering GameStop, the “pitchfork populists arrayed against Wall Street” narrative seems all too facile, or at least overly simplistic — or incomplete.

Any consideration of GameStop should start from the premise that financial markets — and by extension a market economy — are fundamentally amoral. While that may sound damning, amorality is far superior to the colorably immoral nature of various economic and societal structures, such as the petit oligarchy much on the minds (or message boards) of Reddit.

Capital markets, and by extension the larger banking system and financial architecture of which they form a part, are essentially a plumbing function within a modern market economy, intermediating capital by allocating it to its best uses. The existence of secondary market trading, particularly of stocks, is a critical component of capital intermediation. The liquidity associated with tradeable capital reduces the cost and increases the availability of such capital, and the securities and instruments representing capital so traded are not only an inducement to the creation of the primary investment necessary to fund commerce, but also provide a means for investment capital to move from weak to strong hands and allow it to be deployed to where it is most highly valued.

Securities trading can thus be thought of as a necessary feature of market capitalism, albeit at a remove from (or as a component of) the essential function of allocating savings. Speculative trading — including short-selling and day-trading, each of which is implicated in GameStop — can be thought of as at a yet-further remove from capital formation, or effectively a second derivative. As liquid securities markets facilitate capital formation, speculation in turn facilitates liquidity.

Considered in this way, Melvin Capital (a better name for the primary victim of a short squeeze would be difficult to invent) and the WallStreetBets subreddit are each part of a larger financial ecosystem that allows our markets and economy to function optimally. Who “wins” and who “loses” in connection with speculative trading is far less important to the real economy than that in capital markets there exists a game fairly played.

And this is where GameStop matters, and where the story has rightly taken on ideological and policy overtones, even if many of those opining with conviction are only marginally fluent with the technical detail and thematic hues of the moment.

Much has been made over the past week of the delicious irony of hedge funds — one of the many villains out of central casting blamed for the 2008 financial crisis — cast in “white hats” as victims of unwashed day-trading hordes. That such funds are seen as the beneficiaries of an institutional and regulatory circling of the wagons, both actual and prospective, and seemingly designed to protect them at the expense of “small fry” individual investors, isn’t a good look for 21st-century capitalism.

Considering this response in light of 2008 is instructive. During the financial crisis, the great and good of Wall Street — the commercial and investment banks assembling and distributing mortgage-backed securities and providing prime brokerage services to investment funds — were complicit in the ensuing cataclysm, after which financial system losses were socialized without institutional or executive accountability. Then, a strong case could be made that market interventions were appropriate given the significant negative externalities associated with the plumbing backing up, the reasons (and culpability) for it having done so notwithstanding.

No such externalities appear to apply to GameStop, and in fact may militate in the other direction. Regulators should act equally and fairly to enforce applicable regulations related to margin requirements, coordination among investors, and public communications/disclosure, along with the entire existing toolkit available to protect markets and their participants — sometimes from themselves. Similarly, broker-dealers are under no obligation to extend margin credit to institutions or individuals and should ever and always engage in prudent risk management. And hedge funds, of course, are always welcome to be bailed out voluntarily by their hedge fund buddies provided there are willing counterparties on each side of the transaction.

By contrast, for regulators to massage the rules, or for institutions to act in service of protecting incumbents or seemingly favored constituencies, particularly a rentier class at the expense of individual investors, is a dangerous move and one likely to weaken confidence in markets and the fairness of the “game” — whether that game be the capital markets, or how society is organized more generally. Wall Street is already viewed with suspicion by much of society, and those with an interest in a properly functioning economy would be unwise to validate that belief. Moreover, acts that transparently benefit those who are perceived to have extracted continuing economic rents feed every populist trope — properly grounded or otherwise — about American oligarchy and the illegitimacy of elite institutions. The White House and Treasury are reported to be “monitoring the situation closely,” which should give us all significant pause.

In the stock market “game,” Redditors invested in GameStop aren’t supposed to be the Washington Generals. I have no idea whether most of them understand that while speculation can distort markets and asset pricing, intrinsic value ultimately proves out, and the fundamentals do not bode well for GameStop’s long-term prospects. Or perhaps many of them do, and they don’t care. Either way, that this populist-tinged skirmish may not end well for the pitchfork brigades is less important than exactly how it ends — be it well or otherwise. GameStop doesn’t have to be a morality play, or yet another front in the culture wars. Only institutional and governmental actions can make it one.

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Richard J. Shinder is the founder and managing partner of Theatine Partners, a financial consultancy.

 

 

 

 

 

 

 

 

 

 

 


Appeared at and reprinted from The American Spectator

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