Known Unknowns


Hello,

Welcome to Known Unknowns, a newsletter that knows more about what’s good for you than you do.

Should we stop GameStop?

As regular readers know, I have some libertarian tendencies. I don’t claim to know your preferences and values, so if you want to take risks or do things that I wouldn’t, have at it. But sometimes people take risks that they don’t fully understand, either because of lack of training or simply from having bad information. And sometimes those risks pose harm to others, which is normally when the government steps in.

This leads me to GameStop (or today Silver), which is probably one of those things that we’ll forget about in a month or so, because the fact that it happened doesn’t mean that markets are screwed up, or even inefficient. This stuff just happens, especially when a new (risky) technology comes along.

But the whole thing is being framed in an odd way—i.e., that the individual retail investor is rising up against the big, bad hedge funds. This is a compelling narrative, and that’s why it’s all anyone is talking about. And I suppose that could be the takeaway after a single day of trading. But making money in markets requires knowing when to get out (or having power friends who will lend you money when you need it), and I worry about some people betting money they don’t have without realizing the risks that they’re taking on. Taking down a hedge fund is only fun when you make money at it, and we don’t know whether these day traders care so much about taking down big whales until they actually lose money while doing so. And these funds have much deeper pockets and access to a lot more capital. It’s sad to say, but the game is rigged in their favor. So, as satisfying as it may be in the short run, I don’t see it ending well.

It feels like all of these discussions about risk, class, and fairness are dancing around the real question here, a question few will dare to ask: Should retail investors be able to buy individual stocks? Or should we only be able to buy mutual funds?

Investing in individual stocks is risky, and most people would be better off owning an index fund. If they did, they’d make more money on average and face less risk at the same time. Day-trading options are even riskier. So is shorting. My mentor, Robert Merton, has likened owning an individual stock to buying a single piece of car—it’s pretty useless, especially if you don't know what you are doing. After all, a security’s value is largely about how it contributes to your entire portfolio as a whole.

It’s hard to imagine the kind of regulation that forbids retail investors from owning individual stocks. Even if it’s a bad idea for most of us, it’s still how most people think about investing; after all, stock speculation is downright American. People often ask me what stocks I own, and the answer of course is that I only own index funds, with some tilts for a little upside risk—just like the good economist I am.

If we left stock-picking only to institutions, people would cry elitism. Just look at the joy people took in the GameStop story, and the outrage when Robinhood restricted trading—it was like a virtual Occupy Wall Street!

I think Merton is right: owning individual stocks is inefficient for most people. We’d have more money and less risk if we just owned funds, and if we want to encourage more people to invest in the market, that’s what we should aim for. I’m all for democratizing the markets, but for me, that means wider ownership of efficient stock portfolios.

I want to be clear that I don’t think indexing for retail investors is a good idea because it will make life better for hedge funds. They’re taking big risks, too (albeit arguably more informed, better capitalized ones), and what happened with GameStop is part of the risk that they take on. I don’t have much sympathy for them. The argument is about what’s better for the retail investor, and indexing would be better than letting them trade a stock and then subsequently debate shutting down their market access to it when we decide it’s gotten out of hand. Robinhood restricted access to certain stocks because it couldn't execute the trades. This made people angry, but it's just another risk that crops up when you trade small, individual securities on a new, untested platform.

However, what’s right and what’s politically feasible are often two different things.

Economic populism is here to stay

Most economists think that a federal $15 minimum wage is a risky way to increase earnings. The American economy is too diverse for such a high minimum wage. Evidence shows that the most vulnerable workers with marginal labor force attachment pay the biggest cost, and we have better tools to increase pay, such as wage subsidies. Increasing the minimum wage can be useful, but how much and when are important factors to consider. But surveys show that Americans want a $15 minimum wage, and now we have to decide whether we should enact bad policies just because they are popular.

The same goes for Buy American policies. Economists like more global trade, but the idea of making stuff here sounds appealing and safe—even if it isn’t necessarily true. In many ways, it concentrates risk and also leads to higher prices. It also does workers no favors in the long run, since it delays the inevitable economic transition.

But these politics are popular, so does that mean we should do simply move forward regardless of the consequences? I know that we now live in the post-expert world, and no one trusts economists anymore. But does that mean we should support suboptimal policies that can actually make us poorer in the long run?


100-year bond

This is another thing that I think is a great idea that no one else is enthusiastic about. First of all, pensions and insurance companies need more duration. They have very long-term liabilities and a market that in which it’s impossible to find a security that has a duration much longer than 22 years. Perhaps they don’t want to hedge because it’s expensive to do so, and they’d rather invest in hedge funds that short GameStop because it promises higher returns. But it can’t hurt to give them the option to hedge their risk, especially if they can get slightly higher interest rates.

Meanwhile, we’re borrowing like crazy and financing it with short-term debt that we’ll need to roll over. Why not lock these low rates in and remove interest rate risk?

Are we really that worried about what a weak bond auction might reveal?

In other news

Data has become the world’s most valuable currency.

Until next time, Pension Geeks!

Allison