Pandemania

When will the GameStop?

It is worth reflecting on the first major panic on the New York Stock Exchange in 1901. On that occasion two magnates, James Hill and Edward Harriman, one supported by Standard Oil, the other by JP Morgan, were fighting for control of Northern Pacific Railroad company. In the process they inadvertently bankrupted the small investors who were short-selling.^[1]

Allegedly, Harriman accidentally cornered the market and the shares rose 600% in a day. ‘Retail’ investors, betting with leverage – in precisely the same way as they do today on apps and platforms – lost their shirts. Legend has it that a beer brewer in New Jersey jumped into a large vat of boiling beer on receiving news from his broker of his pending financial doom.

The most thoughtful investors, who genuinely are worth listening to, concluded many years ago, that short-selling is a very dangerous game.^[2] When you buy shares, with cash, you can only lose the value of your initial investment. When you short a stock you can lose many multiples of your original exposure. There is no moral right or wrong here – the angels and devils are in the detail of skewed return distributions, nothing else.

As with most mania, there is a great deal that is very misleading about the narratives surrounding this latest variant – and some near-universal truths. Stock markets were never designed with a clear intention. They are Humean ‘spontaneous’ institutions.^[3] In other words, if they didn’t exist, we would quickly invent them, because they do actually serve a function. They provide diversification and insurance. It is no coincidence that growth in international trade typically coincided with the creation of joint-stock companies. Many investments which carry risk would not be embarked upon by a single individual – they only happen because we can share risk between us. One way we diversify our savings is through the ownership of a large diverse holdings of stocks. The returns will be volatile from one year to the next, but over time will reflect the return generated by capital.^[4]

But human life is never so simple. As soon as a company is listed on a stock exchange it stops being a company. Its share price becomes a social signal. As the famous speculator, Jesse Livermore, said ‘the ticker is the best promoter’.

Fluctuating securities prices, like house prices, or even tulips, can have extraordinary effects on human beings. If prices start rising rapidly we become obsessed. Normal conversations and human activity becomes hijacked by stories of fortunes being made or lost overnight, fears of scarcity, fears of looking stupid, copying, panicking.

Mania – the hijacking of normal social life by speculative asset prices – are not difficult to identify. By definition, they make themselves heard, by people who don’t usually talk about stocks, houses or rare earth metals. Be very wary of narratives, not least David against Goliath tales of enraged college students meting out punishment to the titans of wall street who bankrupted their parents in 2008. Hollywood narratives don’t map easily on to mania. The Crucible by Arthur Miller, might be a better a better analogue. Speculative mania is socially-coordinated delusion.

It is a human tragedy that technology is at once the source of great leaps of progress, but also seems capable of super-charging our worst instincts. There is also nothing new in the specific financial games being played in this latest mini-mania. Like the rest of social life, it just moved online. Despite the role of chat rooms, high-frequency platforms and one-click futures and options trading, the past appears to be an even more disconcerting guide than usual. The tulip mania in the 17th century coincided with the bubonic plague in Haarlem in the Netherlands. Financial historians have tended to argue that a plague or pandemic changes our view of risk, but perhaps as some wise observers have suggested, then and now it was inveterate gamblers with more time than usual on their hands who trigger the madness.

In every mania there is also fraud. It is often not illegal, and often very well disguised. Instead of racketeers sending newsletters with buy recommendations to one postcode and sell recommendations to another, now you can post a screen shot of one set of ‘winning’ trades on twitter, keeping the losing opposite position to yourself.

“Pump and dump” is probably as old as the stock market. How does it work? Buy stocks, promote them, create a speculative frenzy and sell them. It’s a variant of a Ponzi scheme. The mathematical certainty is that the greatest losses occur when the reversal inevitably occurs, and the human cost is not insignificant. For every student posting on Twitter that they’ve repaid their student loan, there will be more losing all their savings.

The American nightmare
Watching the train crash of American politics, culture and economic policy over the last five years has been tortuous. The insidious worship of wealth pervading this latest episode is similarly striking.

The pronouncements of billionaires from Silicon Valley, most of whom are notable for being in the right place at the right time, taking the moral high ground against similarly absurd ego-billionaires on Wall Street, reveals a bankrupt culture, in this case leveraged by Twitter.

The moral case for equal access to casino gambling? Please. I take even less comfort hearing the same meme repeated by ‘progressive’ politicians calling for universal access to leveraged futures and options trading.

Some simple truths are worth repeating. The only winner at the casino is the house. The aptly named ‘Robinhood’ trading platform – this one takes from the poor – is the latest variant.

Angrynomics

Mark Blyth and I wrote Angrynomics last year in the midst of the pandemic. We observed on the legacy of the financial crisis and a political class bereft of thought. A deep-seated sense that the economic and financial system was rigged has been hijacked by narratives of tribalism, but also legitimate rebuke over money in politics, intolerable inequality and environmental degradation. Some commentators have countered that moral rebuke and tribal rage are just perspectives based on which side you are on. This is very misleading. Angry sports fans don’t provide reasons for their latent threats of violence. Whether or not you agree with extinction rebellion protestors, or civil rights activists enraged by police brutality, they can both provide clear reasons for their actions.

The noisy moralising in defence of the right to rampant speculation is delusional. Far more pernicious is the deep distrust of our system revealed by the unquestioning acceptance of the narrative that ‘good’ speculators are being foiled by the evil establishment. In vast markets, there is no easy separation or classification of who is involved, and history is almost certain to reveal some embarrassing surprises to anyone who thinks they know.

The real challenge remains for the few enlightened leaders among our political class to deliver a political agenda that means something. Perhaps then, the noise will be harder to hear.

^[1] The nerds among you will find an irony in the fact that I believe Northern pacific railroad became a part of what is now Burlington Northern.

^[2] Warren Buffett and Charlie Munger discuss short-selling.

^[3]https://www.philosophyofmoney.net/the-economics-of-language-david-hume-valuing-facebook/

^[4]A strange meme, which has widespread currency, is that the role of stock markets is to finance investment. This can be the case – but there are lots of ways to finance investment. The is only one way to diversify ownership of capital with liquidity.

Postscript

The shareholder registers of the “pumped” stocks reveals among other global asset managers, the presence of Dimesnionla Fund Advisors high on the shareholder register. Dimensional has around $600bn of global assets under management, but are also notable for the fact that their investment process is based on Fama-French factors. Eugene Fama is an advisor. In phases like the current one, we typically scoff at the nonsense of the efficient market hypothesis. On this occasion, I wonder who is having the last laugh?