Are Free Markets Really Free? What the Gamestop Fiasco Tells Us About Our Capital Markets

As the SEC considers an investigation into the Gamestop Reddit insanity that is consuming Wall Street, politicians are trying to elbow their way into the controversy. Rep Alexandria Ocasio-Cortez and Senator Ted Cruz both appear to both be siding with the online traders against institutions proving–once again–that politics make for some truly strange bedfellows.

Let’s be clear, AOC is not a free market capitalist. But, she does recognize the unfairness of a system that seems to be forbidding individual investors from making individual decisions. I suspect AOC would prefer to have these markets entirely shut down and simply control the world from her ivory tower so she could personally, along with other government head honchos, work to stamp out any perceived inequities by simply shutting down free markets all together.

Senator Ted Cruz, meanwhile, is also taking aim at the Robinhoods of the world, albeit for different (yet, still politically motivated) reasons. His complaint is free markets aren’t really free if they’re not allowing for people to execute the trades they desire.

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The truth in all this lays somewhere in between. Yes. Free markets should enable people to make decisions that they think make sense. Investors bet on whether they think a stock will go up or down. They buy when they think it will go higher, they sell when they think it will go down. And, they should be willing to pay the price if they’re ultimately wrong.

USUALLY, these buying and selling decisions are based on real fundamentals rather than some emotionally rooted desire to “stick it” to the establishment. The reason being, of course, that if a valuation for a company is not actually rooted in fundamentals, well then… the investors that are the last ones holding the stock will get badly burned.

Nonetheless, if individual traders on-line are willing to take that risk, shouldn’t it be theirs to take?

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OR, is Gamestop not a normal risk because it’s being artificially manipulated?

I tend to believe investors should make their own decisions in a free markets. Nonetheless, real decisions are hard to make in a manipulated environment.

Market regulators guard heavily against manipulation because there’s a belief that a market cannot be fair and free if there’s foul play involved.

Don’t Kid Yourself. There’s Always Been Market “Spin” Which Could Be Perceived as Manipulation

There’s always been a certain amount of so-called “spin” that has played into the valuations of stocks, has there not? And therefore, hasn’t some manipulation always been somewhat  tolerated? Perhaps this Gamestock episode has simply exposed the danger of the pile-on effect in a really public way.

The Herbalife Example

If famed billionaire hedge fund trader Bill Ackman decides to short Herbalife (as he once very publicly did) and he wants to present a slide show presentation for why he believes the company is a pyramid scheme (as he did)… isn’t it his right to do so?

Ackman was all over the financial television screens articulating his thesis…though, unlike the Gamestock phenomenon, Ackman’s Herbalife thesis was a well-defined viewpoint, complete with slides and charts and valuations, etc.

Meanwhile, if Carl Icahn thinks Ackman’s thesis is insanity square (as he did)… then, isn’t it Carl Icahn’s right to go long on the company and present his viewpoint? Also, on national television? (Something Icahn did – as a guest on my Bloomberg Television markets program.)

Herbalife took on a life of its own with most traders buying into one side of another based in part on fundamentals…but, yes, most probably also as a Ackman vs Icahn kind of event.

Why was the Herbalife “Battle” Allowed While Gamestop Raises Questions?

It’s an important question to ask. Because what we’re now seeing playing out in chat rooms is effectively a warped (and amplified) version of what the big guys have done for years.

The difference–as far as regulators are concerned–may lay in the concern that this event has gone far beyond any kind of normal trading into the zone of market manipulation and collusion with serious consequences that even involve a kind of systemic risk. Regulators will view this as a deliberate conspiracy to influence a stock’s valuation that’s not based on any real fundamentals or philosophy, but instead, is a deliberate attempt to manipulate manipulating a market and kill the other side of the trade.

This is going to be challenging to prove (although the reddit messages, if they can link them back to the individuals and their traders might help.) Much may come down too intent. After all, who’s to say that some online trader working from his basement really and truly doesn’t believe in prospects of Gamestop? Moreover, if he’s willing to put money in because he believes the stock to be a “cause” why shouldn’t he be able to do so? He, after all, is the one with money at risk.

Systemic Risk?

Meanwhile, there are important systemic questions that trading in Gamestop raises. For example, why are investors allowed to short more than 100% of a stock’s float? Why are they permitted to short up to 150%? This, itself, seems to be a mess-up rule that the Gamestop investors have exposed.

Moreover, there may also need to be higher margin requirements put into place in order to remove additional systemic risk issues.

Don’t get me wrong. Shorts actually play a vital role in the health of the overall markets. If there’s no ability to short a stock, there’s no real market-making capability. Imagine if stocks were like real estate and you literally had to locate the actual buyer and seller of every certificate. That would make for some darn illiquid markets.

So we need shorts to function. It gets a little dicey when a hedge fund targets a short though… but as it gets dicey when a group of investors “target” a company for short or long purposes. And that’s where systemic risk comes into play…the shorts, for example, had a hand in the 2008 financial crisis.

It also gets a little dicey when you consider that these trades actually need to settle. And, when volume and volatility is as high as its been in Gamestop, there are a whole other set of problems for the system. Clearinghouses, as such, are requiring more in the way of margin requirements to process the trades.

Libor Rate Fixing – Is Gamestop Similar?

Meanwhile, when considering the possibility of collusion, one should consider the LIBOR scandal, in which regulators accused banks of “fixing” Libor rates involved a kind of market collusion that may be invoked in the Gamestop case.

If regulators can prove that a series of online traders deliberately conspired together to ignite the stock…with the intention of dumping it at a certain level, then there may be a case.

Free Markets Still Must be Free: 

But, if people are buying a company just because they “want” it …even if just a political statement, then this is going to be challenging for regulators. The reality is markets–generally–tend to work. And, unfortunately, some traders will be left learning that the hard way.

There will be people on both sides of this trade that lose money. And, some that make money. But, when you roll the dice, these are the chances you must be free to take.





Trish Regan

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