SEC Commissioner on Memes, Crypto and Bubbles

At CLA, we're in your corner and on it. We coach tax strategies and Little League first base. We help you adopt AI data tools, and we adopt rescues named Buddy. We walk your factory floor and jog the local 5K, though sometimes we walk that too. Wherever you're coming from, we're right there with you. Wherever you're going, we'll get you there. CLA, CPAs, consultants, and advisors. Learn more at claconnect.com/withyou.

There's nothing wrong with having retail participation in the markets. Retail may see something that other people don't see. And so I think it's probably not right to talk about this as if it's all just uninformed trading. There are people who are thinking quite a bit about the trades they're making.

Hello and welcome to the Barron Streetwise Podcast. I'm Jack Howe. The voice you just heard, that's Hester Peirce. She's a commissioner on the SEC, the Securities and Exchange Commission, America's regulator for financial markets. We spoke recently about meme trading, or frenzied gains in the prices of unlikely assets. It looks to me like bubble-type activity, but don't bubbles usually pop and then disappear for years? This looks more like rolling outbreaks, with some meme stocks going on multiple manic runs separated by mere months. So how does it end? Or does it end? Is it dangerous or just frivolous? We'll hear from Commissioner Peirce and from Brown University economist Mark Blyth. I think of meme trading as bubbly activity, and I think of bubbles as things that form and then pop and then go away. That's what happened with the dot-com stock bubble just over 20 years ago and the bubble that formed during the roaring 1920s. Technically, less than a month after the crash of October 1929, stocks started a huge 6-month rally, but then that fizzled, and in the end, the Dow lost nearly 90% in less than 3 years, and it didn't return to its former high until 1954. Neither of those bubbles seems to have a lot of parallels now. They were both broader and they were formed during periods of sweeping technological change. Some of the stocks even worked out. If you had known in December 1999 that a seller of books by mail would go on to transform American commerce, you could have bought Amazon at its bubble high price of just over $100 a share, and even though you would have ridden it down to single-digit prices over the next 2 years, today your shares would be worth more than $3,400 apiece. The meme trading going on now seems more peripheral, unconnected to economic developments, and I have a difficult time believing that some of the names involved will turn out to have been bargains. I mean, I wish AMC the best of luck, I hope the movie business comes back stronger than ever, but if a theater chain is the next Amazon, I'm just not seeing it. I doubt many of the people trading it see that either. Just like I doubt that traders who piled into the parody cryptocurrency Dogecoin expected it to one day play a meaningful role in the world's monetary system. If we're looking for a past example of an epic bubble in something frivolous, The Dutch Tulip Mania of the 1630s would be perfect, although I'm not sure how much of a mania it really was. A U.S. historian named Anne Goldgar published a book in 2007 called Tulip Mania, which argued convincingly that common perceptions of the tulip bubble are way off. It wasn't a widespread trading frenzy that took down the Dutch economy It was more of a fad where wealthy people paid silly prices for a luxury good during a broader period of vast wealth creation called the Dutch Golden Age. And although tulip prices crashed, there wasn't much by way of broad economic fallout. According to Goldgar, the scope of the tulip bubble was greatly exaggerated in a later 1841 book called 'Extraordinarily Popular Delusions and the Madness of Crowds.' And we've all stuck with that supersized version of the story ever since. So is meme trading a harmless tulip mania that'll pass? And if so, why does it seem to be flaring up again and again? Is it a more worrisome signal for the market? And by the way, what happens to all those cryptocurrencies once interest in them fades? They're not like tulips, which have to be cultivated and cared for. Will cryptocurrencies just live forever on hard drives like decommissioned satellites that have spun out of orbit to become space junk? To learn more about meme trading and where it might lead, I reached out to an economist who has studied popular financial uprisings, Mark Blyth, a Scotland-born professor at Brown University in Rhode Island and co-author of a book last year called "Angrynomics." I asked Mark, how unusual is this period historically speaking? He mentioned well-known bubbles like one in 1720 in shares of a British trading company called South Sea, and of course, Tulip Mania. But he also mentioned a less known bubble.

There's a town in Connecticut called Darien. Most people don't know that that's named after the Darien Project, which was when Scotland, when it was still independent, put a third of its national treasury and all the money it could find from punters into a scheme that put 40 ships all the way to Panama to dig the Panama Canal. They all died of malaria and were murdered by the Spanish. Scotland went bankrupt, and then the Act of Union happened. So there are much bigger things than Dogecoin in terms of how far they can go.

Did Mark just say Dogecoin? And quick follow-up question for myself: have I been pronouncing Dogecoin wrong publicly for months now? Not sure, but I think I might like Dogecoin more. Anyhow, we'll get back to Mark soon. We did an episode on meme trading back in January, and one thing I kept hearing at the time was, "This will end badly." Shares of the video game chain GameStop had shot from less than $5 last summer to over $400 at one point. There was no way to explain that move using the company's business prospects. We talked about chatroom traders, especially ones connected to the Reddit forum WallStreetBets, and zero-commission Robinhood trading accounts, and some of the technical oddities involved in a short squeeze, where investors who've bet against a stock get caught by surprise. As for ending badly, I'm not sure the GameStop kerfuffle has ended at all. The shares did in fact collapse to below $50, Although keep in mind, that was still more than 10 times where they traded last summer. And more recently, the prices shot back up to above $200. And GameStop isn't the only stock having a second spectacular rise in less than 6 months. Back in January, AMC Entertainment, the theater chain, rose from $2 a share to $20 before falling back to single digits. Now it's over $50. AMC has used the run-up to issue massive sums of new shares to the public. Usually, that would result in financial wheel-spinning. The company would get the cash from the new shares, but its stock price would fall to offset the dilution from those shares. But AMC's stock price is still riding high. This is more like guzzling beer to get rich off the 5-cent deposit money and somehow making the math work, at least for now. I'm not exactly sure where all of this leaves us. If you're a regular saver plunking money each month into stock index funds, you're not really affected by swings in AMC's value unless those swings are a sign of a broader bubble. The S&P 500 index is up close to 40% over the past year, which is extraordinary. And it trades at 21 times projected earnings, which is high. But then again, earnings have been rising as quickly as share prices lately. And if you believe companies will continue their recent trend of blowing through earnings estimates, that level of 21 times projected earnings might overstate the market's price. I'm not saying shares are cheap. I'm saying it's unclear that they're alarmingly expensive. And even if they were, historically, that hasn't always led to shares falling in value soon. Okay, back to Mark. He says there are two ways to think about bubbles. You'll hear him mention here Charles Kindleberger, an economic historian who wrote a book called Manias, Panics, and Crashes, and economist Hyman Minsky, for whom the so-called Minsky moment is named. That's when a crash sets in. Here's Mark.

Ultimately, all of this comes down to the two fundamental ways of thinking about bubbles. So the first one is it's a rational process. So you may think Bitcoin's nonsense, but it gets to a point where enough people think it's nonsense in a positive way that you're an idiot if you don't invest in it. And I see this in lots of investment firms open up little bits of crypto here and there. Maybe we should have some in our portfolio. Why? Because it's the kind of digital gold angle, right? Because everybody else thinks it's valuable, it's valuable. So we gotta be in it. So it's rational to do it. The other one is the classic Charles Kindleberger version of events, right? Essentially, you've got some media attention that brings a new idea to a new set of audiences. Those audiences somehow think that this changes the game and gives them an advantage. That initial valuation goes really, really sky high. More and more people pile in. The fact that the price is rising makes naive retail investors even more keen to go in. And then you eventually get to the moment that Minsky called revulsion, when it pops and then it goes down. The trouble with that story is, as you say, there's so many alternatives and so much liquidity out there, things can pop, but then they come back up. They keep going. We're playing whack-a-mole at this point. That's what's new, right? It's that combination of technology and liquidity means that you're just playing whack-a-mole digitally.

The level of interest rates does set the current period apart from past ones. You don't need me to tell you that savings accounts pay next to nothing or that Treasury yields are a fraction of their historical averages. But did you know that even junk bond yields recently slipped below the inflation rate? Here's Mark.

So, so long as you're looking at a world of extremely low interest rates, and despite the current moment, let's say that the inflationary forces of the moment prove to be transitory rather than structural, then there's no reason to think interest rates have any real reason to rise. So you're looking at a very long and steady decline in real interest rates going back by some estimates 700 years, or the '70s and '80s being a weird exception. And we've got structurally low inflation, global supply chains, the whole lot, and too much money trying to find a purpose. So where is it everyone's put some money? They put it into the stock market. That seems to be a perpetual motion machine.

Mark says a couple of things can happen to put a stop to meme mania. One's a spectacular bust where people are forced to book large losses. The second one's a rise in interest rates, which is likely only if inflation heats up and stays hot. We're part of the way there. The U.S. Consumer Price Index rose 5% in May from a year earlier. That's the fastest inflation since 2008. And this past week, the Federal Reserve signaled that it now expects to raise rates by the end of 2023, which is a bit earlier than it had suggested previously. The stock market wobbled on that news, but investors didn't panic. After all, we're still talking about a modest rise from historically low levels, and only if inflation doesn't fade out again like it has over the past decade. The 10-year Treasury yield was recently around 1.5% versus a half-century average of over 5%. If a shift to prolonged elevated inflation were obvious, you'd expect yields to be higher. If we don't get higher yields, Mark says, we might be in for another decade of whack-a-mole or whack-a-meme. He also says we shouldn't be so quick to dismiss that activity as dumb.

You might be a value investor, right? Well, you know, that hasn't had such a great run. You might have a more sophisticated strategy, right? Some kind of straddle strategy or something, some kind of quantitative thing, you know, you're doing. Why are those things more legitimate than someone saying, I bet on the stuff that loads of other people thinking is popular going up in value? In a sense, what I'm doing is a social convention model. The more that people talk about this, the more they think it's going to go up, the more that I know that retail investors will be drawn into it, the more that I can just basically ride their bubble and then make sure that I've got prudential limits and I get out what I think is 80% of their madness. So in a sense, if you think of it as just like this is just another way of playing the market, why should we poo-poo it, particularly if some people at the end of the day are making money?

Mark says that for now at least, meme trading might not be as worrisome or dangerous as we make it out to be. But it doesn't seem beneficial either.

What have they done? Brought a car hire firm back from the dead and made movie theaters big again? The difference with these bubbles, and I think this is an important point, is that if you go back, you mentioned the dot-com bubble. One of the consequences from this was that there was a huge overexpansion of cable capacity, all that fiber optic cable that got laid down by Global Crossing and these firms that went bust and all the rest of it. And thanks to that, 10 years later, we got Netflix. Big bubbles tend to have a kind of long-term positive component. And that all of the overinvestment isn't bad. Some of it's really good. And if you are able to sort of hang around long enough and capitalize on what's left over, then you can really make that go. And that's what happened to dot-com. There's no net positive effect to this stuff, right? There's no law. If this becomes a big bubble and bust, what's left? Hey, we got one more car hire firm. Whoa, rock it out.

There's another way things could change even without interest rates rising and That's if regulators get involved. Maybe they'll want to look at zero-commission stock trading, which is funded with something called payment for order flow, whereby brokers collect fees to direct trades to certain venues. Or maybe they'll look at cryptocurrency. Mark says governments started taking crypto more seriously after Facebook announced plans for its own cryptocurrency called Libra. He also says many of the people powering the crypto craze are traders that are also enthusiastic for meme stocks.

So at the end of the day, if this is powered by the same folks that are enamored by cryptos, and I think that there's a, let's say, a good overlap in the two sets of the people involved in this one, then if China finally just goes, you know what, we're not doing this mining anymore, you're done, and crypto mining gets shut down, And at the same time, central banks around the world, with the Chinese taking the lead, are doing their own central bank digital currencies. Well, why are they doing this? They're doing this because a few years ago they woke up to the fact that Libra could be a private global currency, and if you pardon my language, they collectively pooped their pants. And that's when they woke up to it and said, holy hell, this thing's an actual threat to one of the most important sovereign powers we've got: the right to issue coin.

To learn more about potential regulation, I reached out to a regulator. Hi, Commissioner.

Hi, Jack. How are you?

Thanks so much for taking a few minutes to speak with me.

Oh, my pleasure.

That's Hester Peirce, one of the 5 commissioners serving on America's Securities and Exchange Commission. The SEC has a 3-part mission: to protect investors, to maintain fair and orderly markets, and to facilitate capital formation. For example, companies raising money by issuing the stocks and bonds that we investors buy. Commissioner Peirce has picked up the nickname Crypto Mom for her support for letting the crypto community innovate without too much interference from regulators. She has proposed a set of safe harbor guidelines that would protect financial institutions that deal in crypto from some legal risk. Commissioner Peirce makes clear that her views are not necessarily those of her colleagues. She tends to favor a light regulatory touch.

Well, I mean, I think our country is less a fair country in the sense that we are built on this idea that individuals can make their own decisions. They don't need a government to make decisions for them. Of course, we have a regulatory framework, but that regulatory framework still respects the individual and the individual's intelligence, the individual's understanding of her own circumstances. That's kind of how I approach regulation in general.

I asked Commissioner Peirce for her take on meme trading.

I like to see retail interest in, in participating in our capital markets. The capital markets are not only for a certain segment of the population, they're for everyone to participate in. Now, in this area, as in any other area of life these days, where do you go to get information? Where do you go to exchange ideas? You go online, you talk to people on these social media platforms. That's just the way we live our lives now, and probably even more so because we're in this weird COVID time. But there is a regulatory framework. If someone is manipulating the markets, we have the ability to bring a case. And again, I would caution people, when someone you know, someone famous or a friend of yours tells you to buy something, you know, you probably want to ask, why are you telling me that? Are you getting paid to tell me that?

Commissioner Peirce says she's looking forward to seeing a report on meme trading that the SEC staff is working on now.. They can include recommendations on tightening rules or on enforcement actions. It remains to be seen, she says. I asked, why don't we seem to see the same level of speculative activity in Europe?

I think that the United States in general has more of a tradition of retail ownership of individual securities than some other countries have. That's not a bad tradition. That's a good tradition, but that may make it more likely that people will be involved in this kind of trading activity in the United States than in other places. But again, I think there's also something about this time in our country with COVID shutting everything down and limiting the options of, you know, people are bored, they're looking for things to do, they're sitting in front of their computers.

Commissioner Peirce says we shouldn't think about all meme trading as uninformed. Some of it is, of course, but some participants think deeply about their trades. She says it's good for people to get comfortable participating in markets when they're young. Okay, back to regulation. There are differences of opinion at the SEC, like in any organization. The U.S. president appoints commissioners but doesn't fire them, and the president designates one commissioner as the chairperson. We have a new SEC chair. Gary Gensler, which means we could have a new agenda. I asked Commissioner Peirce, setting aside the regulation you'd like to see, what do you think we're likely to see? She says that change at the SEC tends to be incremental because the rulebook is already, as she puts it, quite thick. She says Chairman Gensler's comments suggest he's interested in cryptocurrency and issues that have come up because of meme trading, including shortening settlement time, or the speed at which money changes hands following stock trades.

People are talking about payment for order flow, something that your average person on the street probably wouldn't have been talking about a year ago, or people are talking about settlement times, you know, should we shorten the settlement time. So I think some of those kinds of issues are certainly on the table. And then with respect to crypto, again, because it's an area that is growing, I do expect that we'll see some regulatory action related to crypto. I hope it's the adoption of my safe harbor, but we'll see if that's what we get.

Thank you for listening. Jackson Cantrell is our producer. Jackson, would you like to tell everyone why you didn't buy Amazon during the dot-com bubble? I was 5. Still no excuse. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. If you listen on Apple, write us a review. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's @JackHough, H-O-U-G-H. See you next week. What's driving the markets this week? What's on investors' minds as they look ahead? Find out on The Markets Podcast from Goldman Sachs. A breakdown of market moves and macro signals in 10 minutes or less. The Markets Podcast from Goldman Sachs. Listen now.