The GameStop frenzy, far from a morality tale of the people showing up Wall Street elites, should show that something is seriously off-kilter about our society.
It’s hard not to be enthralled by the hilarious and slow-motion train wreck that is the GameStop fight, a Wall Street battle over the share price of a small and unimportant in-store retailer of video games. This controversy has drawn comments from dozens of high-profile politicians, billionaires, and even the richest man in the world.
As with any complex event, there are multiple narratives at work. There’s a political story of populists fighting Wall Street insiders, an economic story of speculation and the casino-like nature of Wall Street, and a financial story of middlemen and con artists manipulating both sides. I’m most interested in the institutional story of financial plumbing of our markets, and fundamentally, how money flows through those pipes, from the Federal Reserve into the financial system, and the real economy.
Just how has money, often borrowed, gone into GameStop shares via millions of retail investors? This flow is connected to a basic problem in finance, something I’ve written about before, what is known as the Cantillon Effect. The Cantillon Effect is an observation by 18th-century French economist Richard Cantillon on why money from bailouts reaches Wall Street before it reaches normal people (in his day, it was gold from mines reaching aristocrats, but it’s the same thing). Cantillon observed that the institutional set-up of how money flows matters, and it can and does distort prices and power in a society.
Robinhood, the popular retail brokerage, is a central node of the GameStop story, and has temporarily become a key part of our financial institutional set-up. Robinhood is an online brokerage that offers free trades and an easy way for normal people to borrow money to speculate, with the ability to do it easily and simply from their phones. Robinhood, in turn, borrows money it lends to customers from big banks, and these big banks are backstopped by the Federal Reserve. Cantillon would observe that this brokerage, at least for now, connects large groups of ordinary people to our centers of money printing in a way formerly reserved to Wall Street insiders.
The people behind Robinhood, which involves a mix of Silicon Valley funders and Wall Street types, are attempting to ‘democratize’ finance, which is to make the same capacity to gamble and cheat in markets available to everyone. They are joined by those on the subreddit, Wall Street Bets, a gathering place for millions of angry little guy speculators, full of rage, cynicism, and machismo (or in other words, a normal trading floor).
When Robinhood shut down trading in the stock, we could see the Cantillon Effect at work; severed from the credit system, retail investors had to watch as the stock price of GameStop fell by 40 percent. The next day, Robinhood reopened trading in GameStop, and the price went right back up to near all-time highs. There were all sorts of accusations tossed at Robinhood when it cut off trading, like it was engaged in collusion, doing the bidding of Wall Street, etc. The narrative of populists on Reddit taking on Wall Street is powerful and politicians were persuaded something was rotten. Members of Congress in both parties, such as Alexandria Ocasio-Cortez (D-NY), Ted Cruz (R-TX), Ken Buck (R-CO), Ted Lieu (D-CA), and Elizabeth Warren (D-MA), all weighed in with various arguments, and committees in Congress pledged to hold hearings.
But there’s a very simple and plausible story of why Robinhood shut down, which is that its own financial position was falling apart as GameStop became more volatile. Robinhood has a risky and somewhat sleazy business model; the brokerage encourages its customers to speculate wildly, automatically setting them up in “margin” accounts that let them borrow money from Robinhood to buy stocks. Roughly half of its clients are now in GameStop, and many of them have bought the stock with borrowed money or with a riskier derivative bet known as an option.
Here’s where the risk comes in. Robinhood lends money to its clients, but it has to get that money from somewhere. So it in turn borrows money on a $600 million line of credit from large banks, like Goldman, JP Morgan, Barclays, and Morgan Stanley, in order to offer these loans to its customers. These banks probably got nervous that so much lending was collateralized by GameStop, and wouldn’t let Robinhood continue on its business model of encouraging margin-heavy speculation by its clients unless the brokerage brought in more capital to absorb possible losses. (There are other issues involving financial plumbing, but they are similar—Robinhood needed more capital.)
In other words, Robinhood’s clients and their penchant for borrowing and speculating were putting Robinhood at risk. It’s the old adage, if you borrow a thousand dollars from the bank and you can’t pay it back, you have a problem. If you borrow a billion dollars from the bank and you can’t pay it back, the bank has a problem. In this case, Robinhood’s customers in aggregate had taken on too much risk, which means Robinhood had to raise more money to let them continue trading. Once it had raised that money, it could reopen the casino.
And this brings me to the Cantillon Effect, in which how money travels matters for distributional purposes. There is an endless number of corrupt bailouts and scams that all of us have seen over the past fifteen years, from the financial crisis to bondholders destroying Puerto Rico and Argentina, to the ‘flash crash’ of 2010, to the CARES Act bailout in the spring, which boosted the fortunes of billionaires once again. One of the key reasons for why these bailouts always seem to tilt to the powerful is because that’s how our financial plumbing is set up—the pipes from the Fed to big banks work quite well, those from the Fed to small businesses don’t.
There’s a tremendous amount of rage at this non-neutrality of money, the idea that speculators on Wall Street get access to credit before anyone else. The reason people are so excited about GameStop is because it’s perceived to be addressing this basic unfairness—the hedge funds have finally met their match in the form of the little guy banding together. The combination of Robinhood and Reddit are viewed to be fixing the institutional gap that lets speculators on Wall Street win.
Until GameStop, it seemed to be much harder to borrow money, speculate, and collude if you weren’t on Wall Street. You needed Wall Street’s special tools of Bloomberg terminals, high-speed supercomputers, insider chatter, and the ability to get easy credit from the Federal Reserve or from banks attached to the Federal Reserve. Now you can get the social knowledge and culture of Wall Street on a subreddit, and the addictive gambling tools and easy credit on Robinhood, all on your phone. Or so goes the populist narrative, anyway.
While I love the Trading Places-style plot of the little guy out-rigging the insider market-riggers, there’s a good chance that it’s nonsense. Most of the retail investors betting on GameStop are going to lose their money, and Wall Street is going to be fine. People on Reddit—some of whom are probably professional insiders—are helping men like Donald Foss, who owns half a billion dollars of GameStop; Foss is a billionaire who made his money from subprime auto lending, the sleaziest business imaginable, which he got into in the 1970s from his perch as one of the largest used car salesmen in the country.
This GameStop frenzy, far from a morality tale of the people showing up Wall Street elites, should show that something is seriously off-kilter about our society. From the 1930s to the 1970s, populists like Franklin Delano Roosevelt reworked our financial system to address the Cantillon Effect, making sure that financial plumbing could reach into every community through credit unions, local banks, insurance companies, and limits on finance. When the Federal Reserve pumped money into the economy, it went into housing, factories, wages, and communities. At the same time, with Glass-Steagall and a whole suite of speed bumps for high finance, the pipes from the Fed to big banks had a bit more friction. FDR didn’t eliminate Wall Street, but he did make it irrelevant to our lives.
Today, the Democratic Party, while on policy is improving, has a culture defined by a mix of billionaires, upper class lawyers, academics, and labor leaders, none of whom have much of a relationship to the anger and frustration of a broad swath of young men who have no way to live meaningful commercial lives in an economy based increasingly on speculation and fraud by elites granted amnesty for lawbreaking. President Joe Biden has a tremendous opportunity to break from this dynamic, and carve out a new path. Hopefully his Securities and Exchange Commission pick, Gary Gensler, can begin rooting out the fraud in the markets, and his antitrust picks, still to be named, can begin restoring open markets for goods and services.
Matt Stoller is the author of Goliath: The Hundred Year War Between Monopoly Power and Democracy and Director of Research at the newly-founded American Economic Liberties Project. This column originally appeared in BIG, Stoller’s newsletter on the politics of monopoly. You can subscribe here.