Treasury Secretary Janet L. Yellen met with other regulators on Thursday to discuss the recent market volatility and some wild weeks on Wall Street, in which a crowd of retail investors made the stock soar – in the case of GameStop, more than 1,700 percent – and then plummet to land.
The circumstances surrounding the negotiations that drove the spikes, including the trading platforms like Robinhood that made them possible, have been examined in recent weeks, prompting Yellen to call a meeting with key financial regulators. The risk to volatile trading investors was shown on Thursday, when GameStop fell 35 percent.
The whole episode caused Washington’s financial supervisors to examine whether markets – as they became more democratized by technology and more subject to the whims of social media – changed in ways that require new attention and potentially different regulation. The Treasury did not immediately comment on the meeting.
Ms. Yellen, recently confirmed for her position after being appointed by President Biden, requested a meeting with the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Federal Reserve and the Federal Reserve Bank of New York.
“We really need to make sure that our financial markets are functioning properly and efficiently and that investors are protected,” said Yellen at Good Morning America on Thursday, saying the meeting would be late in the morning. “We need to understand deeply what happened before we took action, but we are certainly looking closely at these events.”
Investors invested in GameStop, AMC, BlackBerry and other assets largely to see how far they could raise the price, rather than because the companies had solid basic fundamentals. They discussed their efforts on Internet forums and caused great market volatility in the process.
Many of the trades were facilitated by the popular trading app Robinhood, which had to temporarily limit some trades to escape financial problems as a large number of shares changed hands.
The oscillations served to underline that a new generation of investors can exert substantial influence, at least when it comes to individual stocks. Robinhood’s trading suspensions also highlighted the platform’s limitations and generated quick criticism from lawmakers from both parties.
The SEC said it was “closely monitoring” the situation on Friday and that it “would act to protect retail investors when the facts demonstrated abusive or manipulative commercial activity prohibited by federal securities laws”.
Although the SEC and, to a more limited extent, the CFTC have greater jurisdiction over the issues at hand, the Fed has a mandate for financial stability and market vision. The New York Fed trading desk is constantly talking to Wall Street. Massachusetts regulators are also investigating one of the cheerleaders for the increase in GameStop’s stock.
Fed officials have consistently adopted a watchful but carefree tone when asked about GameStop in recent days.
“I’m happy that Janet Yellen is bringing all the regulators together to analyze what happened,” Loretta Mester, president of the Federal Reserve Bank of Cleveland, told CNBC on Thursday morning. “We must monitor to ensure that the volatility does not spread to other parts of the financial market. But at this point, this is not one of those types of situation. “
Central bank president Jerome H. Powell declined to comment on GameStop specifically last week. But he rejected the idea that the Fed’s low interest rates and bond buying policies are the major drivers of the recent rise in the stock market.
“The vulnerabilities of financial stability are generally moderate,” he told a news conference last week. “If you look at where it really boosted asset prices, really in the past two months, it’s not monetary policy. It is expectations about vaccines and also fiscal policy. “
Even if the change that GameStop means is not a risk to the financial system, it could encourage regulators to look for new rules, especially given the concerns of lawmakers who have already asked the SEC and others to resolve the situation. Sen. Elizabeth Warren, a Massachusetts Democrat, sent a letter to the SEC last week demanding that she respond with an explanation of how the agency will address market distortions.
“The commission should review recent market activities that affect GameStop and other companies and act to ensure that markets reflect real value, rather than the highly leveraged bets of wealthy traders or those who seek to inflict financial damage on those traders,” wrote Warren.
Securities lawyers said that much of the response will depend on what regulators determine that drove market volatility around GameStop, including the role that retail investors played, whether there was any market manipulation and whether there was adequate disclosure. by market participants – like Robinhood – who facilitated trading.
When it comes to market manipulation, James Angel, a professor of finance at McDonough School of Business at Georgetown University, said he expects the SEC to focus on the role, if any, of major investors like hedge funds in the movement of shares, as well as whether any high-frequency trading strategies have exacerbated the peak.
Angel said it is possible for high-frequency traders to engage in a strategy known as momentum ignition, which involves starting a series of trades with the intention of initiating a rapid movement in the price of a share.
“Any kind of order ignition negotiation designed to manipulate prices is the kind of thing we want them to investigate,” he said.
The role that retail investors have played will be more difficult to address. Many of the small investors who raised the GameStop price did so to “squeeze” hedge funds that bet on falling stock prices. They communicated their motivations in public, on chat forums and social media, did not hide their intention to harm investors on the other side of the deal and often boasted about losing money.
Barbara Roper, director of investor protection at the Consumer Federation of America, said policing this type of behavior will be more difficult for the SEC
“We are better at regulating professional market participants than finding out what to do when the investor population itself is driving this,” said Roper.
The SEC is likely to focus on Robinhood and other technology platforms that made the investment possible, including allowing investors to trade options – a financial product that appears to have exacerbated some of GameStop’s huge price swings. Options are essentially contracts that give the buyer the right to buy or sell a stock at a certain price at some point in the future. Such trading can be risky and disruptive, say market experts.
“The options trading rules are late for review,” said Roper. “It is assumed that there are safeguards that limit options trading to more sophisticated traders or, at least, make sure that investors understand the risks.
Instead, Robinhood and other platforms allowed any investor to buy options with the push of a button.
“The SEC is going to need a chance. My problem is that the problem is largely a problem of leverage and that leverage comes from trading options instead of individual stocks, “said James Cox, professor of securities at Duke University School of Law.” We may really need to think about whether there needs to be a limit to how many options a person can have and is able to execute. ”
[Read more about how options trading might be fueling a stock market bubble.]
In addition to the risks of options trading, the SEC can also focus on whether any of the incentives and marketing that attracted investors to new financial technology platforms has been misleading. Many companies, including Robinhood, have praised the “no-commission” investment, which many investors may have misinterpreted, said Dennis Kelleher, president of Better Markets.
“The reason why many of these people are in the trade arena is that they were induced to do so by a misleading claim that trade is ‘free’ and now many of them think that free money is falling everywhere,” said the Mr. Kelleher said. “The SEC must take the position that anyone who claims directly or indirectly that trading is free is false and misleading to a reasonable investor.”