Last week, an alluring narrative coalesced around a band of Davids taking on the Goliaths of finance. Thousands of so-called retail traders who came together on Reddit have been using apps like Robinhood to buy stock and options of GameStop, the beleaguered video game retailer, jacking up its value some 1,700 percent last month. In the process, they’ve blown up a few hedge funds that had bet on GameStop’s failure.
The appeal of such a narrative is obvious. Wall Street profits have blasted off during the pandemic, while Main Street endures intense and prolonged suffering, a phenomenon that economists call a “K-shaped” recovery. Americans have waited 10 months and counting for consistent relief from the government. So the idea of “get rich quick” schemes, especially ones animated by a zeal for revenge against the billionaire class, are more compelling than ever. But the unfortunate irony is that this desire to stick it to the fat cats of high finance is likely only to spur higher profits for big banks and hedge funds.
The real solution to breaking the power of finance is to rebalance the recession-wracked economy. Rather than gambling on the dubious promise of more Americans gaining access to the casino, it’s time to rewrite the rules to ensure that the house doesn’t always win.
Wall Street’s edge over retail traders remains, as always, structural: superior data; sophisticated, high-frequency trading software. More important, its traders have access to “dark pools,” private exchanges where they send large orders quietly to avoid moving the market against the trade, and “over the counter” markets, where they trade with one another rather than on public exchanges. They pour money into research and rumor chasing, all in an attempt to determine the positions of their competitors.
Armed with its high-frequency trading algorithms and privileged market data, Wall Street will always win out over the thousands of people posting their positions and their plans on public message boards. These retail traders betting on GameStop’s rise may have blown up hedge funds like Melvin Capital, which lost 53 percent of its value in January after betting that GameStop’s stock would fall. But other hedge funds are likely to profit off its troubles in the long run by scooping up a stake in Melvin Capital’s future revenues in exchange for an emergency cash infusion.
One such hedge fund, Citadel LLC, further benefits from the actions of the Robinhood traders. Citadel’s market-making arm and other Wall Street institutions offer Robinhood money to execute its clients’ orders, an arrangement called “Payment for Order Flow.” (The idea was originated by Bernie Madoff in the 1980s. In 2016, the Securities and Exchange Commission questioned whether it should be banned.) Citadel then profits by trading ahead of Robinhood users. It’s possible that banks like Morgan Stanley and Goldman Sachs are also riding high on the GameStop surge, just as they did in the second quarter of the pandemic, when JPMorgan Chase saw record trading revenue because of its ability to profit from market swings.
In this way, the largest Wall Street firms run “flow trading” desks that act as middlemen. They act as both a buyer and a seller of stocks, options and other financial products, while offsetting their own risks through “hedges.” When I worked at Merrill Lynch from 2007 to 2009, the equity derivatives trading desks took in the biggest profits on the most volatile days. That’s because they are mostly agnostic to price movements, essentially making money on volume and market churn.
What this means is that trying to beat Wall Street at its own zero-sum game — one where any gain is offset by an equal-size loss — is a hopeless proposition. Instead, the solution is to fight austerity to save people from the lure of a speculative frenzy.
In a sense, the United States has seen all this before. Clinton-era welfare “reform,” along with his lowering of capital gains taxes and deregulation of the financial services industry, doubled the number of people living in extreme poverty. In the meantime, the rich pulled further ahead and helped inflate the dot-com bubble. Ahead of the 2008 crash, Wall Street banks sold borrowers “cash-out refinance” home loans, with predatory credit filling the gap left by stagnant wages. The crash decimated Black and Latino wealth, which dropped by more than half. In the wake of the 2008 crisis, research showed that gambling in the lotteries increased among those who continued to struggle financially through the recession.
Reddit and Robinhood are driving a new kind of financial lottery: trading cheap options that require giant price moves to become profitable. As further economic support remains in limbo largely because of Republican intransigence, the GameStop narrative may entice many to try their hand at the financial markets. Victor Yakovenko, a physicist at the University of Maryland, found a correlation between speculative bubbles and periods of greatest inequality. But those who tend to make the most during these bubbles are the already wealthy.
Democratizing the economy, then, involves curbing speculation and pouring national resources into lifting up Americans and rebuilding public institutions. Canceling federal student debt, which President Biden can do without Congress, would grow the economy, relieve the disproportionate debt burdens carried by Black and brown borrowers, and incentivize science and engineering graduates to consider careers benefiting the public good. A modest wealth tax could be redirected to priorities like universal child care. Lawmakers should ensure hedge funds aren’t taking advantage of regulatory blind spots to make themselves too big to fail. A very small financial transaction tax could fund investments in reducing the racial wealth gap through programs like baby bonds.
The country needs transformational policies that tackle our dire economic state. Instead, President Biden is entertaining what are most likely insufficient Republican counteroffers to his relief package, as the speculation frenzy moves on to silver.
If there’s one thing I learned on Wall Street, it’s that traders are, at their core, both self-interested and singularly devoted to the zero-sum game. Trying to mimic this with zero-sum policies that seek to supposedly “democratize” access to financial markets and “disrupt” old ways of thinking helped get us into this mess.
But bold investments in public institutions can get us out.
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