WASHINGTON (CN) — A Duke University professor testified at a Senate Banking Committee hearing Tuesday that market volatility in reaction to retail traders has thrown into question the long-term health of the stock market.
Law professor Gina-Gail Fletcher testified that trading in so-called meme stocks – most notably GameStop, which threw markets into turbulence shortly after a more than 1,500% increase in January driven largely by users on social media site Reddit – had raised concern about the integrity and overall health of the market. But with those questions, others had arisen about market regulation and stability.
“The GameStop incident has highlighted public perception of the unfairness of the markets, on the one hand, and raised new concerns about the integrity of stock prices,” Fletcher said in prepared testimony. “As trading in GameStop gained momentum, a narrative of David vs. Goliath coalesced, with the individual Reddit-led investors being cast as David against the short selling, hedge fund Goliaths.”
Keith Gill – a 34-year-old Reddit trading star and YouTube personality who helped to start the wild GameStop surge – was questioned by Congress in a hearing last month examining whether he influenced the market by leading a group of retail traders to boost the stock price. The stock jumped 22% on Tuesday, as a resurgence of investors has given GameStop new traction and popularity.
Senator Sherrod Brown, an Ohio Democrat and the banking committee’s chairman, asked witnesses Tuesday how fixation with instant wealth and Wall Street distracts Americans from economic realities in light of the Covid-19 pandemic.
Teresa Ghilarducci, economics professor at The New School in New York City, pointed to her experience in behavioral economics and said humans are wired psychologically to feel fear when others around them are experiencing great market successes. That produces a certain narrative about economics that is fed by fiction, she said.
“And fear actually causes anxiety. It might cause pulling back, it might cause coming back in, and it fuels bubbles,” Ghilarducci said.
Adasina Social Capital CEO Rachel Robasciotti testified that market volatility meant different things to different investors, and is particularly devastating to households that can’t afford to lose the money. She said GameStop’s movement in January is similar to what investors saw during the Great Recession, with Wall Street’s churning of sub-prime, mortgage-backed securities.
“Market disruptions like this are a problem because, as stated by SEC commissioners in January, extreme stock price volatility has the potential to expose investors to rapid and severe losses and undermine market confidence,” Robasciotti said.
Senators explored whether companies like Robinhood, which uses payment for order flows to profit from its fee-free trading platform, should be further regulated and whether certain securities rules, like the time it takes transactions to process and clear between financial institutions, should be amended.
For example, Virginia Democrat Mark Warner homed in on what he called the misconception that payment for order flows – funneling retail traders’ orders to larger companies for completion – is necessary to increase a firm’s liquidity, or availability of liquid assets like cash.
“If you look at the fact that of the 9,000 securities that are traded the top 10%, less than 1,000 of them, account for about 77% of all that liquidity, say to me that you don’t need that payment for order flow to increase liquidity because you’ve already got liquidity,” Warner said.
Fletcher seemed to agree with Warner’s assessment.
“In terms of the impact of payment for order flow on liquidity, I do not think that payment for order flow is needed for us to achieve liquidity,” the law professor said. “We have a good financial market that we’ve had before payment for order flow and just as you’ve noted, there are jurisdictions such as the United Kingdom and Australia which do not have that payment for order flow and research that I read from the United Kingdom recently, has not indicated that there has been any meaningful decline in their liquidity.”
Witnesses largely agreed that more research was needed looking into various trading platforms, designs and other incentivization for retail traders through phone applications.
Small, built-in chemical triggers, like animated confetti raining down when a user executes a trade, are all areas researchers want to examine to assess the impact of financial apps like Robinhood. The apps could also provide more information about how users are trading stocks.
“Currently, I do not believe that they provide this level of education for retail investors which then allows them to profit off of retail investors engaging in risky behavior that is not wealth maximizing for these investors,” Fletcher said.
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