The Cantillon Effect and GameStop
Why our politics centers around the unreal world of finance.
|Matt Stoller||Feb 1||61||49|
Welcome to BIG, a newsletter about the politics of monopoly and finance. If you’d like to sign up, you can do so here. Or just read on…
Today I’m going to talk about the high-profile fight between speculators over the modest retailer GameStop, which is now on the front pages daily. Our economy has become so concentrated, and financial speculation has so replaced real commercial activity, that how we manipulate the price of meaningless pieces of paper is now imbued with deep moral significance.
To the moon…
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 it 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.
First, let’s briefly go over what happened last week. The New York Times offers the commonly accepted narrative, centering around the online brokerage Robinhood.
An online army of investors, who have been on a mission to challenge the dominance of Wall Street, rapidly bid up the price of stocks like GameStop, entrapping the big-money hedge funds that had bet against the stocks. Some of these individual investors have reaped huge profits, while at least one major hedge fund had to be bailed out after facing huge losses…
In recent weeks, many online investors have used Robinhood to make bets that pushed up the price of GameStop, AMC Entertainment and other stocks that had been widely shorted — or bet against — by hedge funds. That changed on Thursday after the company curbed customer trading in the most popular stocks.
In protest, hundreds of thousands of users joined a campaign to give Robinhood’s app the lowest one-star review and drive the company’s rating down. Some investors also sued Robinhood for the losses they sustained after the company cut off trading in certain stocks and several lawmakers urged regulators to exercise more scrutiny of the company.
Robinhood, the popular retail brokerage, is a central node of this 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%. 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 and politicians in both parties, such as Alexandria Ocasio-Cortez, Ted Cruz, Donald Trump Jr, Ken Buck, Ted Lieu, and Elizabeth Warren, 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 are 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.
The Populism of Equal Cheating
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 a 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.
In fact, much of what Robinhood is now doing shouldn’t be allowed, including encouraging retail clients to be speculating in margin accounts and in options. And my guess is that there are big funds with anonymous people on the subreddit whipping up a furor - pump and dumps on message boards didn’t start in 2021. Ironically, I don’t think they those on WallStreetBets would disagree, I think they would just claim that if you’re going to put a stop to gambling, stop it on Wall Street first. And that’s right, the amount of leverage and/or cheating by hedge funds, big banks, private equity firms, and market-makers like Citadel is likely off the charts.
Still, I worry when I see a populist argument that letting the little guy take speculative risks is a good thing because not doing so means insiders get an advantage. While that is a real and coherent argument, it’s also an argument for deregulating the financial system on behalf of social justice. We’ve fallen into this trap before; the Grey Panthers and Ralph Nader supported deregulating banks in the 1970s because they claimed that the little guy should get access to the depository and borrowing tools that big corporations had through fancy Eurodollar speculative accounts. They won that fight, and America lost in the process.
Still, how did we wind up in a situation where the populist argument is not that cheating is wrong, but that everyone should be allowed to cheat?
An Economy of Bubbles
The basic problem that GameStop is revealing in our economy writ large is that as a society, we are increasingly putting our time, energy, capital and talent we could use to build fun or useful things into gambling or acquiring market power.
A few weeks ago, I talked to a contact in the domestic textile industry, who told me that when the pandemic hit, most companies in that commercial area turned to producing personal protective equipment for government stockpiles. And now we have a domestic supply chain that can meet our own needs for things like N95 masks, which was not true at the beginning of the pandemic. Only, she noted, there’s a problem. The big buyers who represent most hospital purchasing still want to buy from China, even if individual hospitals might want a more reliable domestic producer.
Without action against these buying monopolies and tariffs to stop China from dumping into our markets, these new supply chain will die. This isn’t isolated to textiles, but is a long-standing economy-wide bias towards monopolies and finance and against production of real goods and services. With the current setup of our markets, there’s just no clear reason to be investing in useful enterprise.
Eighteen months ago, when interest rates started to turn negative, I noted that this anti-production bias is causing a very serious problem with how money flows into the real economy.
Very low or negative interest rates mean that investors can’t find any place to place their savings. Investors perceive there are no more factories to build, no distribution centers to create, no new energy systems to research, no more products to create. You can only stuff money under a mattress, and the price of mattresses is going up. Our financial system, in other words, is acting like we have no more social problems to profitably solve.
What is really happening is not that we’ve run out of problems to solve, but that the economy has become a giant “kill zone,” which is a term venture capitalists use to describe areas they can’t invest for fear that a monopolist will crush their company. Extreme market power is evident in tech markets, but it’s systemic in smaller markets as well, like horse shows, puzzles, cheerleading, portable toilets, mixed martial arts, mail sorting software, and a whole lot more.
With an economy of monopolies, there are now large profits with nowhere to go because investment in new production doesn’t make sense if you have market power. Workers have little bargaining power, so the extra money doesn’t go to them. Taxes on capital are low, so the money isn’t heading back to the government. Moreover, a lot of small businesses have been shut down because of the pandemic, so people can’t put their savings into new business even if they wanted to. Monopolies and a corrupted financial system have broken the ability to put money into useful enterprises. So where is it going?
On Friday, a Wall Street contact told me, “Matt, this speculation isn’t just about GameStock, it’s everywhere. I collect basketball cards, and there’s a bubble in these collectibles.” And sure enough, I poked around, and there is. There are endless sites and message boards talking about ‘investing' in cards, with titles like “7 Rookie Cards That Could Double Your Money In 2021”. And the price hikes aren’t happening in old rare vintage cards, but new ones printed relatively recently, like $1.8 million going for a Lebron James or Giannis Antetokounmpo rookie card.
And the pricing pattern tracks the overall speculative fervor we’ve been seeing in the post-financial crisis era. Prices of these cards started going up in 2016, but really started spiking when the pandemic hit and the CARES Act passed. And where there’s speculation, there’s corruption, with ‘grading companies’ playing the same role as the rating agencies during the financial crisis.
Speculating over the value of pieces of card board is crazy, but it gets even crazier when it comes to things like cryptocurrencies, which are nothing but numbers listed in a distributed spreadsheet. The crypto-currency Dogecoin, which was started as a joke, is now worth $8 billion, after Reddit users inflated it by 800% in 24 hours during this GameStop episode. Similarly, bitcoin is worth in aggregate $600 billion, and it has no intrinsic worth and can’t be used to pay taxes (which is what gives sovereign currencies their value).
More worryingly, in the real economy, speculation is everywhere. Before the pandemic, investors couldn’t stop throwing money at WeWork, which was a money-losing business model I called counterfeit capitalism. Tesla, which basically doesn’t make money, is now worth $750 billion, and its owner, Elon Musk, is the richest man in the world. Special-purpose acquisition companies, or SPACs, which are funds selling shares on the stock market without any business model whatsoever, are booming. (Honestly I feel bad saying that Dogecoin has no instrinsic worth, because compared to a SPAC, at least it has a funny name.)
Meanwhile, private equity barons, who control roughly $4 trillion in corporate assets, saw a massive increase from 2019, despite the pandemic, with 8,000 deals announced, the biggest number since the industry began keeping records. And why? Yes, the Cantillon effect.
“Ultimately the lifeblood of private equity is cheap debt,” said Bryce Klempner, partner at consultant McKinsey. “When you’ve got the Fed saying debt will stay cheap for years, plus historically high multiples, the numbers look buoyant — especially if you’re a seller.”
GameStop and dogecoin might be the high-profile versions of speculative fever, but as McKinsey notes, it is everywhere.
The Politics of Cynicism
Most of the politicians speaking out about Robinhood, however, adopted a bizarro populist approach to the speculative fervor. Instead of saying let’s get money into the real economy so it reaches everyone in productive ways, they argue that everyone should have the right to cheat. The one exception is Elizabeth Warren, who made the case that the very speculation itself was dangerous. She asserted that “Casino-like swings in stock prices of GameStop reflect wild levels of speculation that don’t help GameStop’s workers or customers and could lead to market instability,” and demanded that the Securities and Exchange Commission investigate speculators on both sides, and the middlemen.
It was weird to point out, as Warren did, that GameStop has workers and customers. And the pushback online towards Warren was intense, even among her own side. She’s clearly correct, and yet, there’s a reason that it’s very hard to argue for financial regulation in an economy that is incredibly concentrated and unfair, and speculation is one of the few avenues open to a large group of people. Cynicism is the order of the day, at least on the internet.
As usual, America has been in this deeply corrosive mindset before. In researching my book on monopolies, it was hard to find a decade more cynical than the 1920s. While the nation was controlled by finance friendly Republicans, the Democrats did not challenge the Wall Street friendly consensus. In 1929, the head of the Democratic National Committee, John Jakob Raskob, peddled a high-risk get-rich-quick scheme for small investors under the slogan “Everybody Ought to Be Rich,” a sort of populism of the GameStop variant.
The backstory to the cynicism were false promises by elites. In 1920, progressive Senator Hiram Johnson told a colleague that the American people were badly burned by the false promises of World War One, a war based on the premise that it would end all wars and bring democracy to the world. Instead, over a hundred thousand Americans died even as ‘mushroom millionaires’ blossomed domestically. "The war has set back the people for a generation,” he said. “They are docile; and they will not recover from being so for many years.”
A disillusioned public turned inward, bitter, full of venom. That decade, the KKK had more than 4 million members and a merger boom consolidated power in automobiles, electric utilities, grocery stores, and movie houses. People speculated with mad fury, not just the whirring stock market, but for any kind of asset, with an endless series of bubbles starting with Florida real estate and ending with a stock market crash. In the sort of crypto-currency of the time, an ad for a piece of Florida paradise offered land in the “fast-growing city of Nettie,” a city which, at least for those who bought in, had the unfortunate problem of not existing.
I think we’re going through a 1920s mania again. The defining event of our politics is still the great financial crisis of 2008-2012, when our leaders engineered a foreclosure wave for the middle class while reflating financial assets for Wall Street. We did it again with the CARES Act in the spring, where billionaires got everything they needed, but the plumbing to the rest of us is still creaky. I’m not pessimistic, but I get why people are so angry. In this framework, the calls for financial regulations to protect normal investors sound like a demand that we all attend a human resources compliance webinar.
And yet, to genuine populists, 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. Joe Biden has a tremendous opportunity to break from this dynamic, and carve out a new path. Hopefully his Securities and Exchange 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.
At any rate, people need hope and opportunity, and a credible way to live a meaningful life in which they can make some money doing useful business. If they can’t get it through their democratic institutions and have to wallow in corruption, they’ll turn to Dogecoin, GameStop, and con artists, and they will demand the right to cheat and speculate just like the insiders do. And honestly, who can blame them?
Thanks for reading. Send me tips, stories I’ve missed, or comment by clicking on the title of this newsletter. And if you liked this issue of BIG, you can sign up here for more issues of BIG, a newsletter on how to restore fair commerce, innovation and democracy. If you really liked it, read my book, Goliath: The 100-Year War Between Monopoly Power and Democracy.
P.S. I got a lot of feedback on the last issue of BIG. I wrote about how chain pharmacies are screwing up the vaccine roll-out, vs independent pharmacies who are actually quite helpful. Here’s one reader:
A story here from Saranac Lake, NY in the center of the Adirondack Mountains of upstate New York, where we are seeing what I guess is a pretty slow vaccine roll-out, but perhaps not slower than anywhere else. My next door neighbor is a second generation pharmacist and he recently (pre covid) sold, after 70 years, to Walgreens. I don't know the details but he works for Walgreens now and the change happened very suddenly, with almost no notice to his customers. His was apparently the last independent pharmacy in our county and now we're left with a Walgreens and a branch of a regional chain, Kinney Drugs. (here's an article from our under-resourced but still independent daily newspaper: Only non-chain Tri-Lakes pharmacy closes | News, Sports, Jobs - Adirondack Daily Enterprise ) The lower prices you mention may be some part of what makes a buyout from Walgreens attractive.
In what I suspect is an indication of Walgreen's supplier connections: Kinney had a weeks long wait list this winter to get a flu vaccine while Walgreens, we could walk right in and get it immediately. Everyone I've heard of getting the vaccine has either been a hospital employee or forced to drive an hour or more to one of the two small cities in our part of the state.
I am a retired attorney and did a fair amount of plaintiff's antitrust work during my career, so I have been keenly interested in your posts. Here's my anecdote about CVS and vaccines. I went to my local CVS a week or two ago to get my second shingles shot, and I asked the pharmacist when she thought they would be offering Covid-19 vaccinations. She just rolled her eyes and said she had no idea, but that it would be a "madhouse" whenever it finally started. "They aren't going to give us any additional personnel, and they will still expect us to fill 500+ prescriptions every day. I just don't know how that's going to work."
Now, clearly, they won't be able to refrigerate the Pfizer vaccine, so it's Moderna or Johnson & Johnson or bust. I feel sure the same scene is playing out in almost every CVS or Walgreen's pharmacy across the country.