The U.S. share market experienced some of the wildest swings in decades as a result of short squeezes in GameStop and other companies such as AMC Theatres, Dogecoin and Bitcoin. In the case of GameStop a group of stock market enthusiasts coordinated a campaign in an online chat room – Reddit's WallStreetBets and using commission-free trading platforms like Robinhood.
The phenomenon involves a "short squeeze." Short-selling involves borrowing shares and selling them, intending to buy them back later after the price declines. The bet is placed by buying the shares or share options.
I will not dwell on other facts, because they are still emerging as calls emerge for regulators to investigate potential breaches of existing laws and the U.S. government possibly look at the need for regulatory reform.
Possible U.S. securities law violations include making false statements or misrepresentation to the market in relation to the purchase or sale of securities through articles, blogs, and social media with an intent to deceive.
While the details are not yet fully known, looking at the big picture, it seems that several forces have converged to bring about this latest financial crisis. General turbulence in society in recent years is also reflected in the share markets leading in some cases to a blurring of lines between investing, gambling, speculation, price volatility, printing of money via modern monetary theory, etc.
Another factor is the role of the internet and new fintech platforms and innovations that have greatly expanded the players engaged in the market. Thanks also to social media and platforms like Reddit, these players can now easily devise and communicate strategies and coordinate their efforts so that they can compete against the large hedge fund investors and, as seen in the case of GameStop, even disrupt the larger share market.
Other factors include the role of technology in accelerating the speed and automation seen in modern share trading. Indeed, the majority of Wall Street trades today are done between computers via high frequency trading (HFT) which has its own share of problems, popularly chronicled by Michael Lewis in "Flash Boys."
Algorithms relying on key indicators can create an avalanche of buy and sell orders that lead in a matter of seconds to huge and disruptive market swings. Moreover, fintech companies keep introducing new platforms that enable quants and analysts to design, publish and monetize algorithmic strategies enabling investors to bet on auto-pilot based upon algorithms and micro signals. Internet connections also spread globally in seconds and impact markets around the world.
The media have also played a role when sometimes they have allowed representatives tied to big investors to "short and distort," for example by appearing on programs and blurring the line between news and opinion in talking-down a particular company they have targeted for short selling.
Many of these smaller players are driven not solely by profit but have political and ideological motivations. Some are libertarians seeking to disrupt the market. Others point to the fact that Wall Street has played this game for a long time at the expense of the little players and this is their revenge.
Similar games occurred in the global financial crisis of 2008 that brought the world economy to its knees – yet no one went to jail, as banks were bailed out, and deemed "too big to fail."
Trust matters in institutions and structures such as share markets. For example, without trust, people won't put aside their savings, entrepreneurs desiring to create the next big technology advance will not have the capital to fuel their risk taking and new jobs and industries will not be created. When trust in institutions is breached, especially on a significant scale, society as a whole suffers.
Strategies to rebuild trust in our financial markets should be comprehensive and multi-layered. The issues must be studied from multi-disciplinary perspectives and solutions should account for the many and varied factors such as those mentioned above.
Solutions should be derived from the perspectives offered by multiple disciplines such as law, economics, anthropology, politics, psychology, sociology and history. Reforms should consider the following aspects:
Learning from the past. It is important for us to understand, study and learn the lessons from how and why this situation happened.
Profit plus purpose. Part of the problem in this case is that short selling and related practices are open to abuse and have the potential to distort rather than promote a fair and open market.
Strengthen competition laws. Mere changes in regulation, while not in itself enough, is nevertheless important. In recent years, the U.S. Justice Department has not been terribly active in enforcing competition law. Areas needing law reform are more invigorated laws governing fiduciary relationships, stronger laws in relation to unconscionability and unreasonable contracts, and reconceptualized laws governing duties of big tech companies, social media platforms, financial news reporting, and need for accurate information and a level playing field.
Developing an ethical organizational culture. Regulatory reform will have limited impact unless we also address organizational cultures.
Enhancing professional ethics. Investors, stock brokers, lawyers, accountants and other professions working in the financial industry also must renew their values which emphasize the protection and promotion of their client's interests coupled with a wider duty to the highest professional ethics and service of the profession to society.
Use of technology for auditing and transparency. There are many different types of trust. New and ever more powerful technology, enhanced regulatory processes and big data analytics will play important roles in rebuilding trust in our institutions.
Global governance principles. In a global economy with its greater risks of contagion, governance can no longer be confined to one nation. Instead, we need the adoption of global governance principles that will be reflected in the legal and regulatory regimes of all countries.
Trust, having been breached and seriously eroded, will take time to be restored. However, just as a bush fires can lead to future new growth, this re-growth can start at the individual level as we strengthen the relationships in our communities. I remain hopeful that in time, from the financial fires of short squeezes and other such dealings, we may see the emergence of new and creative forms of regulation and organizational cultures that enhance trust in society as a whole.
Eugene Clark is a columnist with China.org.cn. For more information please visit:
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