Robinhood Is Right to Save Day Traders From Themselves

(Bloomberg Opinion) -- If the powers that be could go back in time to dot-com stock trading in 1999 or subprime mortgage lending in 2005, what would they do differently? That's the question that hangs over comments by both the Biden administration and Securities and Exchange Commission as they watch market volatility generated in part by the wild trading in heavily-shorted stocks like GameStop Corp.

The watchful eye of government may have been part of the reason why the trading app, Robinhood Markets, decided on Thursday morning to limit customers to selling their existing positions in certain volatile stocks rather than continuing to let them buy. The rage on social media generated by that decision shows that the private sector making decisions to rein in market excess has its costs, too. Once a bubble gets to a certain point, rage seems inevitable, the only question being whether it happens after the bubble bursts or before, when companies take steps to protect their customers and themselves. Robinhood is likely going to suffer the wrath of the public for its decision, but ultimately they'll be better off than if they had let the bubble get even bigger.

Bursting bubbles leads to anger and blame, as we saw in both the early and late 2000's. Henry Blodget, a former analyst and co-founder of news website Business Insider Inc., was barred from the brokerage industry for his role in recommending tech stocks in the late 1990's. Younger investors may be surprised to learn that Amazon.com Inc. Chief Executive Officer Jeff Bezos was investigated by regulators in 2001 for selling his shares before the stock of Amazon plunged with the rest of the dot-com stocks. Even if the reason for the bubble was the general public getting ahead of themselves -- too much optimism on the nascent internet industry, or simple greed -- it's easier to blame someone else: Wall Street for making bad recommendations; companies for misleading investors or cashing in early; or the Federal Reserve for making monetary policy too easy. And those villains inevitably suffer reputational harm or worse.

We saw a similar dynamic after the bursting of the housing and credit bubbles in 2008. The villains of that crisis, depending upon who you asked, were mortgage underwriters for misleading borrowers about how much house they could afford, or banks for excess leverage and greed, or the Federal Reserve for easy monetary policy, or hedge funds for betting against the housing market and causing homeowners to suffer. 

Nobody wants to see whatever's happening in stocks like GameStop and AMC Entertainment Holdings Inc. to get to that point. Because if history is any guide, blame will be assigned, and the people to blame will not be whoever bought those stocks at high prices, but the companies and media who facilitated those purchases. And as we've seen in prior crises, if bubbles get too big they can have negative consequences for households and workers who were innocent bystanders and never participated in the bubble itself.

Actions being taken this week by RobinHood and other online trading platforms to rein in speculative activity might be what prevents a bigger bubble that could have more broad-based negative consequences. Maybe the dot-com bubble wouldn't have gotten as big if day-trading platforms back then, such as E-Trade, had curtailed speculative activity in 1998.

As we're seeing, stopping the party early has its consequences too. The public will, with good reason, wonder or believe that RobinHood is cutting off investors while they're in the middle of a winning streak, and during a rare time when Main Street is beating Wall Street. Perhaps the company is doing it to protect its Wall Street owners. Or maybe it's just another case of Main Street being unable to catch a break.

But this is probably a damned-if-you-do, damned-if-you-don't situation. It's easy to imagine a scenario where RobinHood lets things play out on their own, and for all we know stocks like GameStop might have doubled or tripled from here. But inevitably, whenever this trend ended, there would be stories of working parents who bought call options because they saw everyone else doing it and lost everything, or people thrown out of work as the bursting bubble had broader economic consequences. Why,  members of Congress will ask, were inexperienced retail investors allowed to speculate in complex derivative contracts at all? So while these preemptive decisions may result in negative consequences for RobinHood and others, the bursting of a bigger bubble would be worse.

RobinHood did the right thing here, but they shouldn't expect any thank you's.

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

Conor Sen is a Bloomberg Opinion columnist. He has been a contributor to the Atlantic and Business Insider.

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