History Has a Warning for GameStop Traders

They say history occurs first as tragedy, then as farce — I fear we’re about to see that in U.S. financial markets.

Two decades ago, U.S. financial markets were riding all-time records. Day traders were using chat rooms to swap what they thought were reliable tips about stocks that were about to pop. Stocks with negative earnings were trading at astronomical valuations by almost any measure. People without any experience in stock market trading — no less any understanding of how to read a financial statement or earnings report — were confidently pouring dollars saved for college tuition or rent into short-term bets on companies they knew little to nothing about.

And the surest sign of mania was this: People found stock market investing terribly entertaining. I remember high school students asking me for stock tips.

It all came to a crashing end as the dot-com bubble burst, blowing up a few companies and several billion dollars of investor savings. And in retrospect, it seemed so obvious. All the signs of a market bubble were there. People chose not to pay attention.

They were warned. I remember giving speeches through the late 1990s alerting the investing public to the risks of stock market downturns. Over the long haul, yes, investing is a wise path to building wealth. Over the short haul, it involves risks and losses — some quite crushing. The wise investor is conditioned by this awareness and never forgets it.

By all indications, today’s investors are repeating the same mistakes. Consider the following: Significant stock movements are now spurred by social-media-driven gossip about the company and short squeezes (when an investor betting against a stock is forced to pay up for shares to cover their position).

Novice investors are learning about investing not through fundamental rules of the road (study the company and its leadership, read its filings, study its markets, consider its price-to-earnings ratios, evaluate its cash generation versus its debt load, review its earnings expectations versus reality, etc.) but rather through a casino-like focus on ticker symbols alone.

It's quite common for novice investors on day-trading platforms to buy a stock for the same reason they might choose a specific color of sweater — for aesthetic purposes only.

This is all terribly familiar. So familiar that I found this passage from a 1999 speech I gave at the National Press Club. Every word of it applies today: “We — as a nation, as investors, as businesses and as regulators — should not get manic about the mania. One day, a little-known company stock soars 38,000 percent after online investors invest using the wrong ticker symbol. Another day, someone fabricates a news story by copying a web page of a news organization and the stock in question rises 32 percent. Or, sadly, it’s an investor who didn’t take the time to appreciate what he was getting into and ended up losing his life savings in one fell swoop. It seems that with every passing day, we come across one story more amazing than the other.”

That’s an apt description of today’s market. Now, with the benefit of hindsight and history, how do we not repeat the dot-com experience as a dark comedy? There are four clear-cut ways that securities regulators, in particular, can contribute to a wiser investing public:

  1. Go after market rumormongers aggressively. The public may be OK with half-truths and fake news in their political lives, but financial markets must have someone looking out for manipulators. It doesn’t take much to create a rumor indicating a company is in play, pumping up the stock and selling into the frenzy. In my time at the Securities and Exchange Commission, we pursued even relatively inconsequential pump-and-dump schemers. No laws need to be written to go after these bad actors — existing laws just need to be enforced.
  2. Evaluate the science behind today’s day-trading platforms. Rules of behavioral psychology undergird all social media and successful internet platforms. Whether it’s through a nudge or some kind of gamification, the platforms are designed to take advantage of human impulses and needs. This is dangerous territory, and the SEC has a right to call on stock market trading platforms to explain their features and how they work. We’ve seen how social media can be manipulated to expose fault lines in our democracy. Are we certain the same isn’t happening in our financial markets? Time to find out.
  3. Play the role of Gloomy Gus. It’s tempting, especially in a politically appointed role, to use the stock market’s new heights as a mark of political genius. But it’s far better if the SEC regularly cautions investors about some of the immutable laws of financial gravity. There's no reason the public shouldn’t be reminded over and over again that it’s far more difficult to recover from a 25% decline than it is to miss out on a 25% gain.
  4. Improve the boilerplate. I rarely read the legal boilerplate warnings on most of the items I buy and use; they seem to be written to induce indifference. Financial-related investor warnings are no different. I’d prefer cigarette-pack-style warnings against investing recklessly. How about a warning on day-trading sites before you execute a stock trade that says: “Are you prepared to see the value of your investment cut in half overnight?” and “Do you need this money to pay your rent?”

For investors who have recently squeezed short sellers successfully, these steps may not mean much. Recent market successes are hard to argue with. But if there’s one thing we’ve seen, recency bias is a powerful force, and it's deadly when combined with fearlessness. If regulators are able to cut through the froth and the noise, introduce a little humility and doubt, they might well condition novice investors to walk before they run, and to tread carefully on a path where others have gone before — and been badly hurt.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Arthur Levitt Jr. is a former chairman of the U.S. Securities and Exchange Commission and a director of Bloomberg LP.

©2021 Bloomberg L.P.

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