National Review Online, February 2, 2021

Bloomberg’s Matt Levine continues to be a tremendous source of insight into the GameStop saga, but one possible response to what has happened, which is set out in one of his must-read articles on this stock’s excellent adventure/bogus journey (take your pick) and buried within the following not-to-be-taken-literally passage, should be treated with caution:

We have discussed before the sort of creaky U.S. rules around who can buy what sorts of risky investments, and I have proposed a simple standard. I call it the “Certificate of Dumb Investment.” Under this standard, anyone can buy diversified low-fee mutual funds to their heart’s content, but to buy dumb stuff—private placements but sure let’s say also volatile meme stocks—you have to go down to the local office of the Securities and Exchange Commission and sign a form saying that you know that what you’re doing is dumb, you know you will probably lose all your money, and you forfeit forever any right to complain. Then you can do whatever dumb thing you want.

Click on the link embedded in Levine’s text to see where he expands (in an article written in 2018) on how his Certificate of Dumb Investment regime would work. Some of this, I reckon (I cannot imagine why) contains just a touch, well, perhaps more than a touch, of hyperbole: “Then you take the form to an SEC employee, who slaps you hard across the face and says ‘really???’ And if you reply ‘yes really’ then she gives you the certificate.”

Nevertheless, Levine’s underlying point (even if the certificate is, as he writes, “a fantasy”) is serious, and if I had to guess, my suspicion is that he would turn the regulatory ratchet further than it should go. On the other hand, the proposition he puts forward here is entirely reasonable:

I am open to compromise on the details. The point is that the right general approach to the problem of people buying dumb investments is to give them much, much, much clearer and starker and scarier warnings before they invest, and then much, much, much less sympathy if they do it anyway.

There is a strong argument to be made that investors sometimes need to be protected from themselves. A significant portion of our regulatory structure is designed to do just that, and rightly so. If I were looking at how to improve it, I’d focus on hacking away at the verbiage found in “disclosure” statements. These are often written in language so dense that the only thing that they disclose is their authors’ mastery of obfuscation. Levine’s “clearer and starker and scarier warnings” sound as if they would do the trick. But based on what we have discovered up to now, that is as far as any rule changes flowing from GameStop’s wild run should go.

Well, now that I come to think of it, there are also some helpful technological fixes that might be applied more widely. As someone who has, in the past, dabbled in leveraged ETFs, I was both amused by, and appreciative of, the way that a pop-up would appear whenever I was entering an order for one of these treacherous little instruments with my online broker. Effectively, the brokerage would ask, “Are you sure”? When I went ahead, and those investments turned sour (which might just occasionally have occurred), I knew that I had only myself to blame. And, yes, since you ask, lessons have been learned.

Beyond a certain point, however, adults must be free to make mistakes, even severe ones, in their investing. That is an integral part of the hubbub of ideas, often extraordinarily stupid ones, that make up a properly functioning market.

Somewhere beneath rules intended to constrain the ability of people to invest in honestly sold (an essential precondition) securities lurks the conceit that for any given security there is a right price, or, at least, an appropriate price range. Eventually that might (in a way) be true, but in the short term the right price for a security (or almost any asset), however seemingly absurd, is located within the spread for which it can be bought or sold at that instant. A few minutes, or even seconds, later that price might change, and when it does that new price is then the right one — until it is not. Were stocks mispriced on October 16, 1987, or were they mispriced at the close the next Monday (my first crash)?

Manipulating a stock price is (as it should be) illegal in most cases, but the faintly premodern notion that there is a “correct” price for a stock haunts rather too much of the discussion around GameStop. Whether a stock is rationally priced or not is an infinitely more sensible question, even if the answer (or answers) will not satisfy those who, whether they acknowledge it or not, are still trying to find that elusive right price.

In the course of the 202i article, Levine notes an idea floated by the Secretary of the Commonwealth of Massachusetts that had been reported in Barron’s:

The top securities regulator in Massachusetts said the New York Stock Exchange should halt trading in GameStop stock for 30 days so it can “cool down.” Retail traders—often using options–have helped propel the stock more than 1,000% this year. On Wednesday alone, shares were up more than 100%.

“I really think at this point it calls upon the regulators, in this case, the New York Stock Exchange, to consider simply suspending it for a month and stop trading it,” William Galvin, the Secretary of the Commonwealth of Massachusetts, told Barron’s. “These small and unsophisticated investors are probably going to get hurt by this.”

To be sure, a good case can be made for market circuit-breakers of the sort we already have, but, except in strictly limited circumstances (such as a pending announcement or a technical difficulty), trading halts in an individual stock should almost always be off limits. The belief that a stock’s price has risen (or fallen) “too far” or “too fast” should not be a reason to suspend a stock in the way that Mr. Galvin is recommending. Fools, if that is what they are, should, if they can, be free to rush in — or out.

This is not to deny that the professionals who warn their clients that a security is too expensive or advise them of the opportunity when, in their view, it is too cheap, can perform a valuable function. Choose the right adviser and you can do very well indeed. However, for all the analytical rigor that often underpins such advice, determining the relationship between current pricing and future valuation will, ultimately, be nothing more than a matter of opinion, and opinions will differ as to what a security should be worth. That, after all, is what makes a market. And what a security should be worth is not the same as what it will be worth, when worth is defined as the price that someone is prepared to pay for it at a particular moment. This ought to be obvious, but (to mention just two fiascos out of many), whether it was the impressively ingenious “metrics” used to justify moon-rocketing valuations during the Dotcom bubble or the rating agencies’ inglorious contribution (a contribution enhanced by the role that they were handed by regulators) to the financial crisis, what ought to be obvious is not.

I am not unsympathetic to the idea that less-informed investors be nudged, as Levine suggested in 2018 (although his nudge would probably be rather too much of a shove), towards: “a diversified portfolio of approved investments (non-penny-stock public companies, mutual funds and exchange-traded funds with modest fees, insured bank accounts, etc.)”

That said, my best guess is that those who buy such funds are (warning wording or not) often lulled into underestimating the risk that comes with them. For that matter, I cannot help wondering if, as such funds grow ever larger (this is especially true of index funds), the danger that they may represent to market stability is fully understood. And then, as more and more actively managed funds embrace the socio-political agenda that comes with ESG investing, there is the little matter of the threat that they may come to pose to shareholder return and, maybe even, over time and however obliquely, to democracy itself.

The latter issues are a topic for another time, but for now we have to face the overwhelming probability that the story of GameStop and, in all likelihood, most or all of the meme team will end in tears. As I noted the other day, with those tears will come calls for tighter regulation, and:

If the relatively recent past is any precedent, that regulation will be heavy-handed, and will result in a market that is far less “democratic” than the Reddit bros would like to see. In the absence of any actionable malpractice, those who have lost out — adults all — will be left to pay the price of their gambling. That experience will be a teaching moment far more compatible with the preservation of free, relatively open markets than anything that our current crop of legislators could dream up. Somehow, I suspect that the opportunity for that teaching moment will be lost, as the rule-setters move in. More clear-eyed investors (large and small) are right to be concerned about what the consequences of that might be.