"The Populist Tide Is Rising" | What Is The Future Of The Financial Revolution?

Below is a complimentary Demography Unplugged research note written on 2/2/21 by Hedgeye Demography analyst Neil Howe. Click here to learn more and subscribe.

NH: So much has been written about Robinhood, GME, and wallstreetbets that I'll try to keep this short and stick to the really big points. Btw, in case you're way behind in the news, the NYT offers this really neat reading guide. So let's plunge right in.

The GME stunt is one more sign that America is getting swept up in a serious market bubble. The evidence is everywhere. The NASDAQ100 is up more than 2X in two years. Bitcoin is up 2X over its prior peak in just three years. IPOs like DASH and SNOW are popping. Blank-check SPACs endorsed by celebrities like Shaq are selling out. New issues are surging. Robinhood is now raising new equity. Thanks to Robinhood, AMC is doing likewise. Tomorrow, who knows, it may be GME... attracting eager new investors with dazzling dreams of resurrected deadmalls.

Behind it all stands Janet (at Treasury) and Jerome (at the Fed). Janet will do everything she can to turn on a Niagara of "aggregate demand" once a massive new stimulus package is rushed through Congress. And Saint Jerome has promised to keep real rates steeply negative for the indefinite future and press the buy button in case equities go down again. Only one thing will kick away these hydraulic market lifters. That is rapidly rising inflation expectations. We're not there yet.

Lesson? Don't try a big short on an "overpriced" name under these conditions. Everything today is overpriced, and the more overpriced it is, the better it's doing. High beta, high debt, high short interest, high spread--you name it, but the riskier (or junkier) it is, the higher it's flying right now relative to the rest of the market.

Keith has been all over this on the Macro Show. Yes, a ticker may go down--as GME now is--but in this sort of market (to paraphrase Keynes) irrationality need not be tied to any definition of solvency.

Populism is ready to smash down the door on Wall Street. The pressure outside the door has been building up for quite a while--and now there's hardly anyone pushing the other way. From AOC and Senator Elizabeth Warren on the left to Senator Ted Cruz and Donald Trump, Jr., on the right, everyone is assailing "the financial elites."  Die-hard Trumper Senator Josh Hawley says Robinhood has proven that "the fix is in" on Wall Street. Even Elon Musk, who vies with Jeff Bezos for world's-richest-man title and who has plenty of reason to hate short-sellers, is congratulating the Reddit "gamestonkers!"

Action by Congress, the SEC, the Justice Department, and state AG's is ready to break through on several fronts, not just in regulating financial markets, but in antitrust, consumer protection, tax policy, and criminal prosecutions.

The public is ready. The rising rich-poor gap, the over-financialization of the U.S. economy, everything "we didn't do but should've done" after the GFC--it will all suddenly be on the table. What political force is now standing in the way? A shattered Republican Party trying desperately to be more-populist-than-thou? I don't think so.

When will the rules get rewritten? Not now, when prices are up and the mood is buoyant. For the time being, it's all just talk. Wait until the bubble is over, markets are way down, the Fed has run out of miracles, and the voters' mood, as interpreted by their faithful representatives, turns surly and vindictive. We may even see a repeat of the "Pecora hearings" by the Senate Committee on Banking and Currency, or so it was called back in the spring of 1932. That was when lead counsel Ferdinand Pecora famously grilled Wall Street tycoons on what the hell happened during the Roaring Twenties.

The hearings resulted in nothing less than the entire institutional firmament that advisors and brokers still have to study for their Series 7 or Series 65 exams: the Securities Exchange Act and Glass-Steagall Act of 1932 and the launching of the SEC itself in 1933.

Triumph of ordinary people? Not hardly. A popular meme out there is that the ability of retail investors to push a few hedgies to the wall after massing online represents a triumph for "ordinary people" and will end up democratizing the choices and perks and privileges of big financial firms.

This "Revolt of the Public," we are told, is overwhelming all institutions from media to politics, and once it's complete the age of the empowered individual will commence.

This is just wrong on so many levels. To begin with, it's unclear whether popular new online platforms like Robinhood help or hurt the typical new retail trader. The biggest GME winners we know about sure don't seem typical to me. Yes, the platforms do popularize the practice of financial investing, which is a good thing. It's wonderful to see more people gaining hands-on experience.

But in return the most celebrated platform, Robinhood, offers significantly inferior "price improvement" over other online retail trading platforms out there. For a typical small trade, Robinhood's owners get paid 10X more than their competitors. Sounds like Robin is getting a kickback from the Sheriff of Nottingham.

Nor do these platforms do much to educate small investors about how to make money over time. Yes, buying lots of OTM options is exciting, like a lottery. But will it tend to make you wealthier over the long run? No, probably the opposite--again, like a lottery. Robinhood, designed by Silicon Valley, seems optimized for the same kind of dopamine rush that you get from Candy Crush. As in the late 90s, the media are again teeming with stories about impoverished day traders who bet their "stimmies" (stimulus checks) on some leveraged long shot.

The final outcome will be less choice (and less risk) for everybody. As for market manipulation, well, I just don't get it: Aren't we really talking here about the democratization of vice. In the case of GME, it's not clear to me that the mob comes off any better than the plutocrats.

The hedgie camp gets blamed for driving the short interest to over 100% of the float--as if that were per se evidence of illegality. Not so. In theory, you can drive the short interest up to any percent if you keep buying, borrowing, and shorting the same shares quick enough.

Which is what the wallstreetbets traders made happen when they kept buying call options, which brokers could only offer (for a huge IV I'm sure) by themselves buying more shares as a hedge.

Another big villain is Robinhood for restricting GME trading when volume soared to the stratosphere. The reason was that clearing houses were requiring it to deposit a lot more cash to cover the risk of settling all those trades. No conspiracy here: All the other online platforms were doing the same for the same reason. And then there's Citadel: The same firm that was financing the GME shorts (through Melvin Capital) is also a major buyer of Robinhood's order flow. Doesn't look good, I know. But there's nothing improper let alone illegal here. Where else is Robinhood going to go to execute its orders? To a government agency?

Now let's look at the insurgent camp. Few of its populist defenders care to point out that most of the insurgents' methods--rallying other investors to pump the price, corner the asset, or thump the volume ("let's all press buy at exactly 3pm!")--are flagrant violations of SEC regs which no institutional player planning to stay in business would dare violate. And btw these regs against manipulation and fraud were put into place expressly to protect the small investor.

Finance law scholars are already citing a litany of broken rules. As for Robinhood's deposits with clearing houses, these requirements were made stiffer after the 2008 crash. Why? Again, to protect the ordinary investor.

In the GME upswing, the media assumed that the small investor was the net winner, but that was a mere assumption unbacked by evidence. As a rule, the informed insiders who engineer a market stampede always do better than the latecomers who merely pile on.

After the GME episode, waving a red flag before the Reddit community could easily become just one more clever way for insiders to make money. (Go long the name and then start badmouthing it and insulting the day traders who think they can stop you.)

Even in the art of manipulating market memes, professionals working in anonymous markets will always maintain an edge. And perversely the die-hard populist holdouts who get all the online plaudits for solidarity and keeping the faith, well, they are guaranteed to lose the most. Over the last couple of days, I'm sure this happened again: They were the ones riding the price back down.

With not even the insurgents arguing that GME is a worthwhile economic investment, there is a near-universal agreement that all this nets out to a zero-sum transfer (actually negative sum once you figure in all the trading costs and time loss). You might also call it something akin to a well-hyped chain letter or ponzi scheme. The earliest and most-informed originators win, the latest and least-informed lose, and society gains nothing. Such activities in any other context have long been illegal. And by the time regulators and legislators are ready to act, IMO they won't see this kind of market mayhem much differently.

If you believe in capitalism, you do have reason to be worried. Benjamin Graham is once supposed to have said, "In the short run, the stock market is a voting machine. In the long run, it is a weighing machine." We all may wonder just how long that "long run" takes to manifest itself--in some cases, it may be a very long time indeed. But here's the important point.

Once the public comes to believe that the stock market is only a voting machine, they are likely to see it as nothing but legalized financial mayhem, featuring lots of predators and victims but generating no significant benefits to the community at large. And when that happens, the public may choose to put much heavier constraints on just what a stock market is allowed to do.

As we argue over what happened in the GME drama, we may wonder what does or does not constitute "fraud" or "manipulation" in the eyes of the SEC or FINRA or securities laws. What do such words mean, anyway? Historically, it's fair to say that they are informed by the answer to a very simple question: Does the activity, in context, tend to change prices in a way that moves economic resources in a more efficient, more informed, or more socially beneficial direction? If yes, that is, if it is really helping the market perform its weighing function, then the presumption is that it should be protected. But if not, not.

This exegesis may not please libertarians, many of whom feel that legality is predicated on rights with no regard to social utility. But that argument struggles against the current in a democracy.

If conspiring to flashmob individual investors is permitted, the larger players will band together into protection rackets. In time, our financial sector will become even more wasteful and less legitimate than it already is while not leaving anybody better off, least of all the "small investor."

The populist tide is rising. Those who believe in capitalism may soon have to defend the proposition that capital markets actually do perform an important role in the health of our economy and nation. And they may have to defend it against a multitude of skeptics who will point to last week's circus as proof the system is a travesty.

Seventy years ago, in an earlier era of rising populism, FDR once declared that his New Deal saved capitalism. In 1933, specifically, he observed that “it was this administration which saved the system of private profit and free enterprise after it had been dragged to the brink of ruin.” Yes, that was the year the SEC first set up shop.

Capitalists had better start thinking hard about what is defensible and what isn't. History may be coming round once again.

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ABOUT NEIL HOWE

Neil Howe is a renowned authority on generations and social change in America. An acclaimed bestselling author and speaker, he is the nation's leading thinker on today's generations—who they are, what motivates them, and how they will shape America's future.

A historian, economist, and demographer, Howe is also a recognized authority on global aging, long-term fiscal policy, and migration. He is a senior associate to the Center for Strategic and International Studies (CSIS) in Washington, D.C., where he helps direct the CSIS Global Aging Initiative.

Howe has written over a dozen books on generations, demographic change, and fiscal policy, many of them with William Strauss. Howe and Strauss' first book, Generations is a history of America told as a sequence of generational biographies. Vice President Al Gore called it "the most stimulating book on American history that I have ever read" and sent a copy to every member of Congress. Newt Gingrich called it "an intellectual tour de force." Of their book, The Fourth Turning, The Boston Globe wrote, "If Howe and Strauss are right, they will take their place among the great American prophets."

Howe and Strauss originally coined the term "Millennial Generation" in 1991, and wrote the pioneering book on this generation, Millennials Rising. His work has been featured frequently in the media, including USA Today, CNN, the New York Times, and CBS' 60 Minutes.

Previously, with Peter G. Peterson, Howe co-authored On Borrowed Time, a pioneering call for budgetary reform and The Graying of the Great Powers with Richard Jackson.

Howe received his B.A. at U.C. Berkeley and later earned graduate degrees in economics and history from Yale University.