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Government Fueled The GameStop Mania And Shouldn’t Make It Worse

History has shown us over and over again that government 'fixes' just worsen the very problems government created to begin with.

While the GameStop saga continues to unfold, the call for government intervention has only gotten louder as a group of mostly amateur investors — connected through social media and trading apps — has made several well-known Wall Street firms with large short positions in GameStop stocks bleed billions of dollars.

White House Press Secretary Jen Psaki announced that President Biden’s economic team and Treasury Secretary Janet Yellen are closely “monitoring” the situation. Sen. Elizabeth Warren is pressuring the Security and Exchange Commission for new regulations. House Speaker Nancy Pelosi, D-Calif., said Congress would be part of the GameStop scrutiny.

One major question remains, however: Can government fix a problem it helped create?

The GameStop trading tale began when several well-known Wall Street firms, including Melvin Capital and Point72 Asset Management, believed that brick and mortar businesses like GameStop were dying, so they bet that the stock price of Gamestop would go down significantly. They were so confident in their assessment that they sold an apparent 140 percent of Gamestop shares available to purchase.

In any normal time, they probably would be raking in billions by now. After all, they are the professionals — the experts who knew the level of risks they were taking and have successfully pulled off such moves many times before.

We do not, however, live in normal times. The pandemic and our government’s responses have changed everything.

First, the lockdowns led to many first-time investors. Our government responded to the COVID-19 pandemic by shutting down the majority of our economy and forcing many Americans to stay at home for most of 2020, while giving many still-employed people extra cash.

The prolonged lockdowns, isolation, and unemployment for many have left people feeling bored and restless. People are hungry for social interaction, yearning for the sense of belonging that comes with an authentic community, and desperately seeking things to do that would both kill the extra time and bring some excitement into life.

Some people who never traded stocks before the lockdowns found their way to stock investing for the first time because trading stock was something new, stimulating, engrossing, and even addicting. Through discussion boards such as r/WallStreetBets — a discussion group on Reddit.com — and other social media platforms they found other like-minded people, a sense of community belonging, and the excitement that had been denied for months due to government lockdowns.

Robinhood, a trading app, has seen its user base grow more than 30 percent and trading volumes grow more than 130 percent between the first and second quarter of 2020, indicating that government lockdowns created a new generation of retail investors.

Second, the Federal Reserve created a stock market bubble. To minimize the economic damages caused by government lockdowns, the Federal Reserve pumped an additional $3 trillion into the U.S. financial system. This excessive money printing, along with the Fed’s decision to keep the key interest rate near zero, created little incentive for savings, pushing more yield-seeking investors into the stock market, and producing a stock market bubble that is often disconnected from the struggling economy.

The higher the stock market euphoria went, the more it became attractive to Americans from all walks of life, including many who never invested before. The low borrowing cost and widely available liquidity also encouraged risky behaviors such as using options to make outsized bets to seek higher returns. But the size of loss might be doubled or tripled if the bets were wrong.

Third, for some, stimulus checks became capital for stock trading. The U.S. government rushed out a $2 trillion stimulus package at the end of last March, hoping to “save” the economy from the downturn caused by lockdown policies. As part of this package, every American who was 18 or older, regardless of their financial needs, received a $1,200 stimulus check.

Government planners had hoped that Americans would spend their stimulus money to stimulate the economy. To the surprise and dismay of the bureaucrats, however, more than two-thirds of Americans chose to either save their stimulus money or use it to pay down debt instead of spending it.

Some used the government check as initial capital to invest in the stock market for the first time. The way they saw it: since the stimulus check was “free money” they didn’t expect anyway, if they lost it in the stock market, it wouldn’t hurt. Because of limited capital, first-time investors tend to invest in beaten-down stocks of companies they are familiar with, such as AMC Entertainment Holdings and GameStop (of course, AMC was itself a victim of government lockdowns).

In summary, this was a response to government-imposed lockdowns that crashed our economy, cost millions of jobs, sent good companies to the brink of bankruptcy, and drove down their stock prices. Then the government came to the “rescue” with money-printing, creating a stock market bubble and providing seed capital for investing. Stay-at-home orders and unemployment gave birth to a new generation of retail investors. Now, investors more apt to wear pajama pants all day while trading from their smartphones have taken down suit-wearing, jet-trotting Wall Street professionals.

Yes, government policies helped create today’s GameStop mania. Now, in typical government tone-deaf fashion, it will try to “fix” it. Yet history has shown us over and over again that government “fixes” usually make the problems they created much worse. As President Reagan famously said: “Government is not a solution to our problem, government is the problem.”

This time is no exception. Any new rules and regulations that will either restrict short-selling or the ability of retail investors to trade securities will further distort the stock market and only hamper confidence in our financial market.

The reason we have the world’s most successful financial market is that participants believe our financial market is more efficient, transparent, and fairer than any other financial markets in the world.

If our government imposes any new rules that give an impression that it favors one group of investors over the others, many more investors will regard our financial market as a rigged system and lose faith in it. This will be detrimental not only to our financial market but also to the foundation of our entire economic system. Congress and the Biden administration need to keep that in mind before they rush out any “fixes.”

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