The GameStop phenomenon is just a saga within the revolution that is making assets of all types more liquid and the cost of capital for illiquid assets cheaper than ever. Nonetheless, stock markets are just a distraction from the measures that truly underpin the health of our economies.
Many of us watched in awe, and some on Wall Street in agony, as last month an 8.5-million strong online forum of “degenerates,” a term the followers of the forum use to refer to themselves, on Reddit, a social media website, caused ruckus in the world of high finance. The members of the forum called WallStreetBets decided to bid up the prices of many abstruse companies, chief among them a retailer of video games, GameStop. The members of the forum decided to stick it to the big guys, hedge fund managers often with billions in assets under management, on the Wall Street who had accumulated sizable short-positions in some of these securities with the expectation of them falling in prices. As they bid up the price of GameStop shares from a few dollars in 2020 to about $480 on January 28 of this year, some hedge funds lost billions of dollars.
Convenient as it may be to call this phenomenon an ad-hoc congregation of like-minded millennials sticking it to the big guy, this has transpired in the backdrop of a few confluencing trends. Cheap debt, through an unprecedented expansionary monetary policy in the rich world, has been readily available to companies. Without avenues to dispense their disposable income, Americans have saved up piles of cash–JP Morgan’s cash deposits last year have risen by over $550 billion. Low interest rates have made equities more attractive, in comparison to fixed income financial instruments. As these factors shored up the stock markets in the middle of a pandemic, technology had already been seeping through the cracks for years to make trading more affordable and frictionless. Individual investors have gotten more informed with massive information flows. Platforms such as Robinhood, which make trading “free” for the retail investors, are ushering in a financial revolution, the hallmarks of which are liquidity, price-transparency, and competition. In January 2021 individual investors contributed to about a quarter of all trading activity, compared to less than 10% in 2019.
Back in the day, banks acted as intermediaries in the stock market. The tech-savvy Robinhoods of the world enlist high-frequency market-makers, such as Citadel, to execute individual orders. Market-makers pay a fixed fee per trade to the trading service for directing the individual trades (order-flow) to them, as they profit from the differential between the price charged to individual investors and the market price. The brokers usually make degrees of magnitude more on sophisticated, and often riskier, instruments such as options, than they make on stocks. In the last quarter of 2020, a number of market makers, chief among them are Citadel and Global Execution Brokers, paid over $195 million to Robinhood and $128 million to TD Ameritrade, another online trading platform and brokerage service.
Stock brokers are not the only sector of the financial intermediaries who are currently being disrupted by technology. Fragmentation and, therefore, low trading volumes still persist in various asset classes: the way real-estate and fixed income securities are traded is ripe for disruption. Take the sluggish residential property market in America: less than 5% of homes are traded every year with sellers paying as much as 5-6% of the asset prices in commissions. Cadre, founded by Ryan Williams in 2014, is trying to build a digital exchange for property. Zillow and Redfin have spent years building massive databases of US home prices, with the assumption that price accuracy means lower transaction costs for customers in the long-term. Similarly, bond-market prices have become increasingly less fragmented and more liquid with the advent of open-ended index funds.
This revolutionary financial progress, which transforms many bystanders to participants in the system, is just accelerating with potentially vast gains to the society at large. Robin Sharma, a motivational speaker, quipped in an unrelated context, “change is hard in the beginning, messy in the middle, but glorious in the end.” This financial revolution is still gyrating in the messy territory. Individual investors, with free access to trading at their fingertips, while disciplined along the way for participating in irrational behavior, will learn and survive; frothy assets, like always, will collapse; and, economic fundamentalism–at least in the long-term–will emerge supreme.
Frictionless as the trading platforms may have made trading, we should take trading platforms’ proclamation of ‘democratizing markets’ with a pinch of salt. Markets and democracy are hardly the same ideals. Increasingly, in the last four decades, the appreciation in asset prices has become the lens through which we view, and often measure, the health of our economies. American dream thrived in years when income growth, not asset growth, led by secure employment formed the foundation of prosperity. An economy that primarily depends upon consumer spending is in turn dependent upon asset price inflation. Stock markets have always been, and will continue to be, volatile. The ability of a bunch of teenagers to whimsically stir up asset prices hardly accentuates ideals of liberal democracy. A country’s fascination with the stock markets prioritizes wealth rather than wage growth. Speculative trading does not achieve democratic ends, but rather deviates us from the most important pillar of American prosperity–wage growth.
Views expressed above are the author’s own.
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