Yellen’s Concern About GameStop Trading Is Misplaced

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Lawmakers and regulators are in danger of learning the wrong lessons from the GameStop Corp. saga, but it’s not too late to correct course.

The showdown between hedge funds and retail investors on Reddit is getting a lot of attention in Washington. Treasury Secretary Janet Yellen met with the top U.S. financial regulators on Thursday, including heads of the Securities and Exchange Commission, the Federal Reserve Board, the Commodity Futures Trading Commission and the Federal Reserve Bank of New York, which is the central bank’s eyes and ears on Wall Street. Two House and Senate committees have also promised to conduct hearings.

The fuss is a bit odd. After all, the financial system is in good shape, and markets don’t appear to be the slightest bit bothered. The stock market’s daily moves have been well within their usual range since the clash between hedgies and Redditors began last month, and there’s been no discernible impact on bond markets or beyond. 

Sure, GameStop and a few other stocks caught in the crossfire have been on a wild ride, but there’s nothing unusual about that. GameStop and AMC Entertainment Holdings Inc., another stock that hedgies and Redditors fought over, have been the most volatile two stocks in the Russell 3000 Index over the past 20 days, according to Bloomberg data. Not far behind, though, are shares of Express Inc., Gritstone Oncology Inc. and Vaxart Inc., three stocks no one is talking about. Look back and you’ll find many others that went bonkers for a while.  

Nor is GameStop’s stock unusually disconnected from the company’s underlying business, as many people wringing their hands about market efficiency have suggested. GameStop hasn’t turned a profit since 2018, but it’s hardly alone. About a third of the companies in the Russell 3000 lose money. Of the roughly 2,300 companies in the index for which a price-to-cash flow ratio can be calculated, 386 of them have a higher ratio than GameStop. And of the roughly 2,800 companies for which a price-to-sales ratio is available, more than 2,100 have a higher ratio than GameStop.

So why the fuss? I wrote last week that when lawmakers and regulators start poking around markets, it’s too often a misguided attempt to clamp down on retail investors in the name of investor protection. And it looks increasingly as if that’s where things are headed. “We really need to make sure that our financial markets are functioning properly, efficiently and that investors are protected,” Yellen told “Good Morning America” on Thursday morning. By any measure, markets are functioning properly and efficiently, or at least as efficiently as usual. That leaves “investor” protection to worry about, by which regulators mean retail investors.   

Both Republican and Democratic lawmakers have thrown their support behind retail investors, but attempts to protect them, however well intentioned, risk rolling back the progress made to democratize markets in recent years. Representative Maxine Waters, chair of the House Financial Services Committee, has promised to convene a hearing “with a focus on short selling, online trading platforms, gamification and their systemic impact on our capital markets and retail investors.” Those are some of the tools that have opened markets to everyone.

Yellen and other policy makers have also insisted they want to promote the fairness and integrity of markets, but moves aimed at protecting retail investors inevitably undermine those goals.  There’s simply no fair way to restrict access for some investors and not others. Retail investors are still excluded from private markets and hedge funds. Fairness, of course, requires that everyone play by the same rules. When that isn’t the case, market integrity takes a hit, too.

It’s no wonder many retail investors believe markets are rigged against them, a perception that Robinhood Markets and other trading apps unfortunately reinforced when they restricted trading in GameStop and other stocks while hedge funds remained free to trade. The best way to promote fairness and integrity is simply to give everyone equal access. 

There’s also a practical problem with treating some investors differently than others. It’s getting harder to tell the difference between unsophisticated investors who need protection and savvier ones who don’t. Securities laws distinguish between retail and more “sophisticated” investors based on income and wealth, the assumption being that the rich are more sophisticated because they have more investing experience and better access to information. But information is now available to everyone, including financial data. And as the GameStop saga has shown, some retail investors are every bit as sophisticated as hedge funds, even if their bank accounts don’t measure up. So wealth and income are no longer useful differentiators.

If policy makers want to protect investors as well as the fairness and integrity of markets, they should help unsophisticated investors get savvier rather than put gates around all retail investors. The best way to do that is to educate investors about the pitfalls of financial markets and then give them the opportunity to gain investing experience.

It’s not as big a lift as it might seem. Retail investors are better informed now than ever. Many are moving their money to low-cost index funds — indeed, the two biggest and perhaps most powerful money managers on the planet are index fund purveyors BlackRock Inc. and Vanguard Group. And during the coronavirus-induced market selloff last March, the vast majority of retail investors managed to hang on to their investments. That is not a picture of dopey investors who need protection. If anything, regulators should consider whether their notion of retail investors as unsophisticated rubes is outdated. 

Former Treasury and White House official Tony Fratto noted recently that Treasury secretaries can use the bully pulpit to seek regulatory change. If Yellen wants to promote fairness and integrity, it’s time to remove the barriers that have long denied retail investors equal access to financial markets.

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

Nir Kaissar is a Bloomberg Opinion columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.

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