What we refer to as the law, written statutes or regulations outlining specific penalties for certain behaviors, doesn’t govern most every day interactions. There’s no law saying that you have to get in line at the grocery store, but everyone does, because that’s what we’ve always done. We rely on traditions built up over decades, knowing that unwritten rules of fair play will be observed. What happens when we throw out those rules? A quick escalation of rule-breaking, one that makes everybody worse-off. The recent kerfuffle with GameStop is illustrative, and it should serve as a warning to those willing to erode governmental traditions for short term wins.
What happened? Most recently, Robinhood – a website that allows users to trade stocks without a per-trade fee – stopped allowing trades of certain highly-volatile stocks, including GameStop. The net result is that the populist traders who use Robinhood were locked out of these trades, while the elites still had access through traditional hedge funds. Outrage was swift, with a class action suit filed, and Robinhood quickly reversed its decision.
But these actions and reactions didn’t happen in a vacuum: the volatility of the subject stocks appears to be the result of a targeted attack – a short squeeze – on those same traditional hedge funds. Many hedge funds have been short-selling GameStop and other stocks that have been hit hard by lockdown policies. Short selling, in very simple terms, is a bet that the price of a stock is going to go down. Rather than buying stock, the short seller borrows it, with a promise to repay it at a later date. He then sells the stock, hoping to buy it back at a lower price to repay the debt. If the price does fall, the short-seller makes money on the difference between the original higher price and the new lower price. If the stock price goes up, however, the short-seller stands to lose.
Just how risky this kind of trading is came to light when a group of Robinhood traders on Reddit got together and bought shares of GameStop, AMC (the movie theater chains), and other stocks that traditional brokerages had shorted, pumping up the price. Whether the move was a sophomoric prank, a concerted attempt at retribution against “the man,” or a get rich quick scheme, seems immaterial compared to the billions of dollars hedge funds have lost on their short positions. The traditional brokerages seemingly have a justifiable bone to pick.
But do they?
Stock portfolios used to represent true investments – a desire to lend capitol to promising companies, in return for a share of the eventual profits. Now they tend to look more like stacks of casino chips. Short-selling, credit default swaps, and other novel “investment” instruments are a legal way of betting on the economy. Hedge funds changed the rules of the game so they could make a profit when they believed a company was on shaky ground. But shorting isn’t much different than betting on a football game. People who think they know the outcome of a future event want to make money on their supposed knowledge. Does a losing brokerage really have a leg to stand on when they cry foul? Isn’t it like having your star quarterback knocked out on the first play of a game? You made the bet, knowing something terrible might happen. You now have to live with the consequences.
So what lessons can this teach us about governance? First lesson: if you change the rules of the game for your benefit, someone else will change them at your expense. This very public backfiring should serve as a clear warning to those wanting to change the rules mid game. Politicians, take heed. For example, if you pack the supreme court when you’re in power, the other side will pack it when they’re in power. They will also find a way to bring it even further under their control. If you eliminate the filibuster for lower courts, will the other side eliminate it for the supremes?
Second lesson: history is a seesaw, with each new generation blaming the breakdown of order on those before them. Traditional brokers are furious with Robinhood traders for intentionally disrupting their short positions. The Robinhood traders wanted to hurt the traditional brokerages because they felt they had been locked out of big gains in the stock market for decades. In politics, the left screams about Merrick Garland, while the right can point to Robert Bork. In reality, senate rejections of supreme court nominees date all the way back to George Washington’s failed nomination of John Rutledge. Republicans nuked the filibuster for supreme court nominations; Democrats did it first for lower court nominees.
Institutions matter. Damaging them for short term gains, even when done legally, can hurt you in the long run. Laws don’t cover every eventuality. Unwritten rules govern a shocking amount of our lives, even within government institutions. If you break these rules for your own profit, expect that someone else will break them to hurt you down the road. Don’t short-sell your integrity.
Mike Davis is Research Fellow at 1889 Institute. He can be reached at [email protected].
The opinions expressed in this blog are those of the author, and do not necessarily reflect the official position of 1889 Institute.