The Capitol riot and GameStop mania might be signs of a new, chaotic direction for the US — or one final bout of madness before calm is restored

  • Both the Capitol riot and the GameStop mania have revealed the instability of our institutions.
  • These events could be a sign of more chaos or a last bout of wildness before normalcy.
  • Whether we go down one path or the other depends on how the government and society responds.
  • Dan Alpert is an adjunct professor at Cornell Law School and a founding managing partner of the New York investment bank Westwood Capital LLC.
  • This is an opinion column. The thoughts expressed are those of the author.
  • Visit the Business section of Insider for more stories.

The month of January is named after Janus, the Roman god of both beginnings and transitions. 

There were plenty of both last month. The advent of the Biden administration — together with a fully unified Democratic Congress — certainly marked a new beginning. 

But beyond that fresh start, the month was also marred by darker, more foreboding events that we can only hope are merely temporary convulsions as we begin the slow transition out of the pandemic and the fact-free world of the past few years.

The shock of the storming of the US Capitol by a conspiracy theory-fueled mob wore off a bit in the glow of a new, normative presidency. No sooner, however, did we begin to move towards the ordinary and orderly, then we were again astounded by the virtual storming of Wall Street in the form of the GameStop mania.

Both events exposed anarchic realities, which have been clear for keen observers for some time: the dysfunction of our government and the lifting of the curtain to reveal Keynes’s “casino capitalism” in secondary capital markets. 

Whether our current chaotic present descends into further madness or is just a temporary stop on the path to a stronger, brighter future depends on how effectively we confront the fact-free narratives gripping both our government and financial markets.

Our institutions have become unmoored

The blinders are off now on the supposed importance of the public equity markets in price discovery and the provider of liquidity that is said to be vital to the process of actual capital formation. Capital formation, or the actual channeling of new investment capital into businesses, has largely retreated to the sphere of experts running private investment and venture funds.

Public markets now pose more danger than support for orderly finance. Given the chaos of the public market and its divorce from fundamental realities, it should come as no great shock that since 1996 the number of publicly listed companies in the US has fallen by nearly half. 

Similarly, the deliberative institutions of government themselves have become a danger to the survival of self-government. Rather than acting as the guardian of our democracy, our legislative bodies have ceded policymaking to technocrats and executive orders.

The extremism of those motivated by deftly-targeted falsehoods about our government yields its own grievance culture when their inanity is denigrated and brought to a halt by the rest of us. The gripes of Trump’s MAGA-crowd are well known and, after years of enabling a false equivalence between some of their most outrageous claims and the actual truth, many in the media have finally rejected this misguided premise

And now, we are seeing a mirror of that political misinformation take hold in financial markets. There are myriad stories from those who have participated in the financial markets as though they were playing a game of video poker on claiming abuse at the hands of “Wall Street.” But these claims that micro-brokerages like Robinhood and WeBull have somehow wronged investors by halting the purchase of “meme stocks” is as outrageous as those who invaded the Capitol building complaining about the police crackdown against them after the fact. 

A narrative not based in fact

The so-called “retail frenzy” in the shares of heavily shorted or otherwise disfavored companies such as GameStop, AMC Theatres and Blackberry (hey, I still use a Blackberry!) was brought to a temporary halt when the micro-brokerages ran out of the cash they needed to post with the large firms that actually clear their orders in the markets. In fact, the entire business model of these gamified peddlers of “stonks” is based on willingness of huge market-makers like Citadel Securities to pay them for order flow (which the large firms use to profit from the small gaps between the bid and asking prices for securities).

The micro-brokerages need to guarantee trades by their customers between the time that orders are placed and when trades close, or settle, which is usually two days later. This means they have to put up cash until then.

When trading volume went sky high last week, they needed to take a pause in order to find new cash to use as this collateral. So they stopped taking orders and – not unsurprisingly – shares in the frenzy-impacted companies tanked. Believe me, I have no love lost for the dangerous micro-brokerages themselves, or their business model. But contrary to the absurd narrative that these platforms were “targeting” innocent retail traders at Wall Street’s whim, they truly had no choice in the matter. 

As for the “meme stocks” themselves, challenging negative sentiment towards heavily-shorted stocks is a legitimate trading strategy. The rising price of such a stock will eventually force those with short positions, or bets against the stock, to buy the stock and close out their short positions rather than experience greater losses. And those purchases will tend to drive the stock price still-higher in what is known on the street as a “short squeeze.” 

Short squeezes are therefore typically incremental and brief. And they certainly do not see prices of affected shares, such as those of GameStop, rise by 2400% in a matter of days.  But a short squeeze that pushes prices beyond rational levels will inevitably produce a rash of selling by those who have bought the stock or derivatives thereof, and are now at risk. We are seeing that now.

Yes, a few institutional shorts lost some money which result appears to count as a badge of honor among the vulgar users of the subreddit, WallStreetBets. But that is not my concern. I am alarmed, as I was on January 6 about our ability to govern ourselves, about the commitment of investors and regulators alike to maintain orderly markets that serve the good of the economy.

The equity markets were already bid up to unsustainable levels reflecting desperation for returns before this latest assault commenced. And for those of deciding whether to own a stock based on its value and fundamentals, this is a time of extreme pause.

Not only have equity prices entered stratospheric territory, but we are now experiencing manipulation that cannot be tied to the machinations of some wealthy evil-doer or a cabal of fund managers – who can be tracked down and prosecuted for same – but by an enormous mob acting in concert, each wielding small amounts with money as their weapon — much as the mob of crazies at the Capitol wielded pikes and clubs. 

Both of these groups have been driven by collective madness that is unquestionably enabled by the epistemological crisis that has emerged from the control of information we have ceded to an advertising algorithm-driven internet. 

What we should do about the internet as a whole, to protect political intercourse, is a subject for further debate. But what we need to do to bring regulation of the markets into the current century is becoming increasingly clear. 

We need a new generation of market circuit breakers that block small order consolidation amid high levels of volatility. Order consolidation and payments for order flow as a business model is not necessary for the operation of efficient markets, and we might consider doing away with the practice entirely. But most importantly, we need to broaden our definition of market manipulation to include internet-based conspiracies engineered by masses of individuals, just as we pursue those of large malevolent players seeking to corner markets. 

Just as those who reject political norms use freedom of speech to justify their inanity, I am sure those who gather together on the internet to bring down markets, even boasting of their willingness to lose money doing so, will do the same. But the freedom of markets is rooted in the rules we use to govern them, just as civil freedom can only be assured by the rule of law. And both require new tools to deal with dangers posed by the collective action of enraged mobs.

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