This Game must Stop: Why we need stock market reform

The system is rigged, right?

Well, yes. But not the way you might think.

Anybody can invest in the stock market. There is no barrier other than needing something to invest. You don’t need a financial advisor, a college degree, or any other form of pedigree to open an account and buy stock.

It is another common myth that this is a rich man’s game. Millions of hard-working people invest in the stock market with every paycheck so one day they can retire without being forced to eat cat food. The trick is making sure you don’t end up losing more than you make. This requires a little knowledge and a lot of patience.

The current system allows sophisticated investors to engage in a variety of confusing transactions like shorts, puts, options and what’s known as “day trading.” These are all based on speculation and the promise of easy money. The problem here is that investors can make (and lose) big bucks this way and it’s completely legal. But where is that money coming from?

It’s not coming from innovation, productivity, or an increase in real value; it’s coming from the same pot of money that serious long-term investors paid to ensure their future retirement. The investors who game the system are not investing, per se, they are gambling. And while it’s currently legal, when they reap their rewards, others lose.

You can’t blame people for being angry at institutional investors for shorting Gamestop. Instead of using their wealth to grow a business, they used it to bet on a company’s failure.

As the famed economist John Maynard Keynes said in his theory known as Keynesian Economics, “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill done.”

America seems to value capitalism above all else, including democracy. This may be attributed to a weak interpretation of Adam Smith’s 1776 publication The Wealth of Nations. For over 200 years, it has been cited as an argument for unfettered capitalism based on the idea that if a person works to his own benefit, he will naturally benefit others.

But we have tried the unfettered version of capitalism and it has failed us. Today the disparity between rich and poor is greater than ever and growing.

This is, in part, because the most oft repeated argument taken from Smith’s opus is false. As Keynes put it “Capitalism is the extraordinary belief that the nastiest of men, for the nastiest of reasons, will somehow work for the benefit of us all.”

Unfortunately, greedy and unscrupulous men do not work for the benefit of all. The rules they play by are weighted in their favor, at the expense of everyone else. This is the game that needs to be stopped.

Elizabeth Warren believes that regulatory control of the market is needed to protect the system from being abused. Smith understood this, but despite his understanding of this conundrum, his response was to promote better behavior by emphasizing morality, a solution conveniently left out of most economic discussions.

We cannot rely on people to do the right thing. The sad fact is that regulation is our only recourse. Just as we have laws against stealing cars, we need laws to prevent theft of equity.

Another reason the gap between rich and poor is so large is due to ignorance. Were any of you offered a course in investing for retirement in school? I wasn’t. I even took an economics class in college, and while I became a wiz at double-entry bookkeeping, I don’t recall learning a thing about investing in the market. Nor was I taught that putting money in a bank without investing it was tantamount to throwing money away.

(FYI: $200 invested monthly at 5% compounding annually results in about a quarter of a million in 40 years. The same amount shoved under your mattress, or left in a non-interest-bearing account, gets you a whopping $96k over the same time span).

In addition, we cannot deny the impact of institutionalized racism on income inequality. People of color have suffered in a myriad of ways due to business practices that have long discriminated against them (more on this in the next installment).

The China Hustle, is a documentary about another legal scheme to siphon money from unsuspecting investors. It started as a scam to overvalue worthless foreign assets but ended as another short scheme, with dire consequences for many individuals who lost their entire life savings as a result.

(The following summary of the scheme comes entirely from the documentary referenced, above. I’ve been unable to find confirming evidence anywhere else.)

Here’s the short (no pun intended) version:

Institutional investors found worthless Chinese companies, bought unused tickers on the U.S. stock market, and assigned those tickers to these Chinese companies. When they filed with the SEC, they substantially inflated the value of these companies on forms that nobody is required to vet. Then they sought out American investors who knew nothing about China or its companies and promised they’d get rich by investing in the "China growth story.” It did not end well. When a couple of investors who were suspicious of these companies decided to investigate, they confirmed the valuations of these companies were indeed inflated.

They took their evidence to Congress. Congress wasn’t interested.

The investors who paid for the research that uncovered these bogus valuations, blew the whistle. But not before they shorted the companies. When word got out in the marketplace that the investments were a scam, the big money investors got richer and the little guys who trusted these same investors with their life savings lost everything. And so it goes.

So, back to Gamestop.

Big investors short the stock. But this time, Elon Musk gets on Twitter and complains about it. And before you know it people start getting mad. It’s righteous indignation, to be sure. How dare these people devalue a company just so they can keep lining their pockets! As the furor increases, small investors start buying Gamestop shares en masse.

The market value (which is based on how many people want the stock, not what the company is worth) goes crazy. Gamestop jumps from its pre-pandemic $4/share to $480/share.

But there’s a problem: Gamestop isn’t worth $480/share. It went up because so many people played the market at the same time. And some of them may not be in a position to lose a lot of money. When it all settles down, there’s no telling what the stock will be worth.

If you timed this perfectly and sold your shares at $480/share, then good for you. But if you paid more than it’s worth now, you’ll likely lose. Because it’s probably not going back to $480. During the dot.com bust, companies that increased their market price due to speculation eventually returned to their real value. And a lot of people who thought they’d be getting rich, lost out.

There’s nothing wrong with people saying “no” to the big institutional investors. It’s far past time to stop the manipulation of the market that favors wealthy investors who have the means to gamble with fortunes. But the Gamestop ploy isn’t the way to do it. Wealthy institutional investors can afford to take a big hit now and again. But I’m willing to bet that most of the folks who tried to beat the Wall Street crowd by investing in Gamestop can’t.

Even as the little guy stuck it to Wall Street investors, the power still belongs to big money; hence, the halt to Gamestop trading by TD Ameritrade and The New York Stock Exchange. If you were mad when you bought Gamestop stock, you must have been furious if you tried to sell and you couldn’t.

There is a solution: regulation. Let’s put a stop to this trading game instead of making bets against Gamestop.

In the meantime, it’s still possible to invest in the market over the long run without being victimized by institutionalized investors. This is true even if you are just a working stiff with a small amount of income to invest. Anyone can turn $200/month into a quarter of a million dollars over the course of your working life.

This is possible and it’s based on a realistic, low-risk scenario that only requires you to understand two things about the market:

-       Compound interest

-       Index funds

However, you also need to be consistent, patient, and disciplined. This is not a get-rich-quick scheme. If you’re interested in learning more about how to invest safely for long haul, stay tuned.

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In the meantime, feel free to post questions in the comments section. I’ll be sure to include answers (if I know them) when I post again. And if I don’t, I’ll do my best to point you in the right direction.