Why market manias worry so many on Wall Street

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First came the GameStop mania. Then it was troubled theater chain AMC. And on Monday, the frenzy of chat room-driven trading sent the price of silver soaring to its highest level in nearly a decade.

None of the moves had much to do with underlying economic fundamentals. Instead, the fevered trading of the last week shows all the markings of a market mania that historically ends in big losses for small traders, sharp pull-backs by big investors and regulatory investigations paired with hand-wringing congressional hearings that drag on for years long after the damage is done.

Wall Street already has been defying gravity for the last year, soaring to record highs and lofty valuations in the face of a brutal global pandemic that still poses considerable economic risks as virus variants spread before vaccines can take hold.

All of it has left veteran market watchers, Wall Street executives and regulators fearing a painful gut-punch for investors like those that rocked the nation when the dot-com craze tanked in 2001 and the housing market collapsed in 2008.

This time it’s social media — which has driven politics in bewildering directions over the last several years — pumping up what look like multiple bubbles that could burst in painful ways.

“There is a huge question about the role of social media here and there are just no regulations around it,” the chief executive officer of one of Wall Street’s largest firms said in a recent interview with a clear note of panic in his voice. “Anyone can go on these platforms and tout a stock or a commodity they own and get a big following and then dump it. It’s pump and dump in a totally new, viral format and there are huge risks that need to be looked at right now or we could be in very serious trouble.”

On Monday, shares in GameStop, the struggling retailer championed by investors on the Reddit forum WallStreetBets, declined by about 30 percent to $225.00, sliced in half from their peak but still over 1,000 percent higher than where they began the year.

Online trading platform Robinhood Markets Inc., whose game-like approach to investing facilitated much of the rise in GameStop and AMC shares, managed to raise another $2.4 billion from investors, avoiding what some market players feared could be a contagion moment after the broker stumbled repeatedly last week.

But the frenzy moved into the silver market following posts by WallStreetBets users urging small investors to put a squeeze on hedge funds similar to the one that hammered short-sellers in GameStop last week. Short-sellers bet on stocks or commodities to fall in value, often using borrowed money to do it. When their bets go wrong, the losses can be devastating. Silver futures climbed 9.3 percent to $29.398 per ounce, the biggest gain since 2009.

The overall stock market, after a tough week, actually rose on Monday as the excitement around GameStop and AMC appeared to be fading. But market watchers are monitoring a larger phenomenon that could have longer-run implications: The Internet-driven populist sentiment that helped propel politicians to national office is now coursing through global markets with potentially dangerous outcomes.

Some segments of the younger generation, flush with extra cash in part due to stimulus payments and weighed down by boredom during the Covid-19 pandemic, are looking to exact a measure of vengeance on big Wall Street hedge funds and the giant brokerage firms that lend them cash.

Politicians thus far have mostly lauded the small investor phenomena and called for hearings on platforms like Robinhood at least temporarily halting the ability of investors to continue buying shares in GameStop. But the fear among leading analysts is that the phenomena are blowing up bubbles that could burst and create market turmoil that weighs down small investors, the broader market and economies around the world still struggling under the impact of Covid-19.

“We are now living through the greatest disconnect between financial markets and the real economy that we have ever seen,” said Mohamed A. El-Erian, president of Queens College Cambridge and chief economic adviser to German investment giant Allianz. “And we now have younger retail investors who have disposable cash, are savvy at social media and have cost-free platforms.”

With easy money policies enacted by central banks across the world, including the U.S. Federal Reserve, it’s relatively easy for companies like Robinhood to keep raising money and for investors to keep pumping cash into questionable assets that could easily come crashing down.

“This is why it feels a lot like the housing market in 2008, only now bubbles are appearing all over the place,” El-Erian said. “Several things could cause this to blow up in a very messy way including a market accident. And we came very close to that with Robinhood last week.”

The political threads of the latest market mania are complex as are the ways Washington could react. Both House and Senate committees have called for hearings about Robinhood and its trading slowdown.

Sen. Elizabeth Warren (D-Mass.), perhaps Wall Street’s biggest critic in Washington, has questioned all sides in the latest market craze. “We actually don’t know who all the players are in all this — whether there’s big money on both sides,” Warren said on CNN on Sunday about GameStop. “That’s why we need an SEC investigation.”

The Biden White House and leading regulators have all said they are “monitoring” the whipsaw market moves. In addition to addressing whether brokerage firms tried to slow or stop trading in GameStop and other assets to protect themselves and their hedge fund clients, regulators are likely to consider whether social media users are manipulating markets in ways that could leave small investors with major losses.

But all of these hearings and investigations are in very early phases. And Washington is also largely preoccupied with Covid and talks over a fresh stimulus package.

If the virus worsens and the U.S. economy falters further, the broader stock market — not just GameStop — could come under renewed pressure, amplified by some of the latest market troubles, well before Congress or any regulator can do anything to intervene.

“A solution for this entire market dislocation will take time and that could suggest this insane trading will continue a little while longer,” Edward Moya, senior market analyst at trading firm OANDA said in a note to clients. “There was a lot of froth in the stock market before retail traders took GameStop and other companies with terrible fundamentals to astronomical valuations. Wall Street is broken.”

Other market watchers noted that the strong tendency toward populist surges — which dates to the Occupy Wall Street movement in the wake of the 2008 financial crisis on the left and the rise of Donald Trump on the right — suggest that any efforts to contain the wave of retail investor activism could fail with potentially disastrous fallout.

“This is all very much a sign of the future,” said Jim Bianco, president and macro strategist at Bianco Research. “For 20 years we’ve had more and more information available. Now you have zero commission trades and you’ve removed any costs and disadvantages” for small investors. “What people have done is found a weakness and exploited it.”

The Wall Street CEO said privately he feared that while brokerages and hedge funds could take big hits, retail investors chasing the latest Internet-driven investing fads will ultimately face the brunt of potential losses.

“Sure, some hedge funds are going to lose money and some smaller ones may fail and that’s fine,” the CEO said. “But most will be fine. The big brokers and banks will be fine. It’s retail investors who will be left holding the bag and getting hurt.”

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