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Regulators must leave investors the chance to be spectacularly wrong


Financial regulators exist to stop anyone ever losing any money and to protect us from ourselves, right?

Many people seem to think so.

As the GameStop drama reached its zenith, a clamour went up.

“Where are the regulators? Something must be done!”

My view was closer to that of the president of the Minneapolis Federal Reserve:

“If one group of speculators wants to have a battle of wills with another group of speculators over an individual stock, God bless them… If they make money, fine. And if they lose money, that’s on them.”

Neel Kashkari, on Bloomberg via Twitter

Of course, seeing sophisticates like Chamath Palihapitiya, Mark Cuban, and Jordan Belfont (the real Wolf of Wall Street) cheering on retail punters – many of whom clearly had no exit plan – made me uneasy.

Those big guns can handle themselves. So too can the sophisticated sliver of Redditors who first proposed GameStop as a target.

But the masses from Robinhood were already looking at unsustainable profits by the time GameStop had all our attention.

What they needed to do was to get out.

As I wrote:

As for those long GameStop who say they’ll hold at any price – they’re probably already dead, in trading terms. They just don’t know it yet.

Praying your stock turns into a Ponzi scheme – with ever more new money coming in to keep it elevated – isn’t trading, let alone investing.

Sturm und damn

As I write GameStop is priced at $61, having peaked at $483 just a week ago.

You’d hope new traders are learning lessons about risk management, position sizing, taking profits, and market structure.

But most will more likely cheer on this Tweet from entertaining stock gambler Dave Portnoy:

Robinhood and other brokers restricting GameStop at the height of the frenzy – for operational reasons, such as capital requirements – probably did help burst the bubble.

But the price was always going to fall from the artificial levels achieved on the back of shorts caught off-guard.

Besides, if you want to play this game, you need to know things happen – from margin calls and getting stopped out to your platform bailing on you.

There’s a scene in The Big Short where one of the managers realizes the bank facilitating his wager against the US mortgage market could go bust.

His apocalyptic bet could be right – but the bank might not be around to pay up.

That’s the level of paranoia you need when markets are roiling on your trades.

Why regulators?

You might think I’ve just made the case for more intervention by regulators.

Self-proclaimed dumb money pitted against professionals in fast markets with platforms taking away the ball mid-game…it’s hardly sober investing for your old age.

But remember why we can even have this discussion.

For decades, direct investing was for the rich. They knew the game and could afford to play.

Perhaps the purest manifestation were the wealthy Lloyds names who profited in the London insurance market for centuries – at the risk of unlimited personal liability.

But even with investing in shares, fees were horrendous, information unevenly distributed, and what we’d now call insider trading was rife.

Ordinary people could eventually pool their money into active funds. But returns were often poor, and the charges astronomical. (Think 5% upfront just to get a fund to take your money, and it didn’t get much better after that.)

Today is very different.

Information is abundant. Brokers like Freetrade charge nothing for trades. Anyone who passes an identity check can deal in all kinds of securities. Cheap index funds enable 99% of people to get the exposure they need.

Of course now that people have access to far more financial products and securities, there’s more scope for things to go wrong, too.

And some people still believe the markets are rigged against them, despite this democratization of finance.

Hence the Bat-signals regularly sent out to the regulators. With every mishap comes a call for more intervention to protect poor investors.

I say be you’re careful what you wish for.

Our hard won parity with richer or more sophisticated investors could be lost to overzealous regulation.

Banking crisis

Many Reddit traders said they wanted to take revenge on Wall Street. And Twitter is full of claims the market is ‘rigged’.

It’s all a great cover for overly nanny-ish regulators to dial back many of the freedoms these new traders prize.

Luckily, regulators seem to be more sensible so far.

A few politicians have made noises. But from what I’ve heard from the regulators, their focus is on ensuring the system holds up and remains well-capitalized.

Most especially they want to avoid a cascade, where one platform borks and its partners and counter-parties fall like dominoes.

Still, considering all the red tape introduced after 2008 – such as the Dodd-Frank Act in the US – we might ask why there still always this call for regulators?

One reason must be the lingering lack of faith that resulted from that crisis.

It’s hard to remember now just how revered bankers had become before the crash (they were seen as near-infallible) and how often we were told things were made more resilient by all the complex financial plumbing.

Despite (or perhaps, it was implied, even because of) so-called light-touch regulation.

Oops!

That claim didn’t age well.

Payment Protection racket

Many who say they want justice cite the lack of repercussions – especially jail time – for the bankers at the heart of the crash as their casus belli.

Countless more bankers walked away with big bonuses than went to jail.

But one big difference – in the UK – was the billions forced out of the banks as a result of the (mostly unrelated) Payment Protection Insurance scandal.

The total bill for PPI claims against mis-selling came to over £53bn.

A staggering sum. I personally think it was excessive.

No doubt many customers hadn’t bothered to read up on what the PPI they were paying for did.

But I don’t believe banks genuinely hoodwinked customers out of £53bn, or anything like it.

When I was looking to buy a flat in the early 2000s, almost every article I read about mortgages mentioned PPI – and told me I probably didn’t need it. If I was cajoled into getting a PPI-bolt-on, I would have gone elsewhere.

But many buyers just signed paperwork blindly. They didn’t do any homework.

Anyway, after the regulators ruled the banks had mis-sold PPI, early estimates of the provisions quickly snowballed.

Shady companies sprang up, cold-calling us into making a claim.

In the end people who had never heard of PPI were getting compensation for forgotten credit cards they’d been perfectly happy with at the time.

I know it’s hard to have sympathy for big banks who cynically tacked unneeded costs onto their dockets.

But if we don’t expect people to try to know what they’re buying when they borrow four-times their annual salaries or more, when should we?

It’s a very slippery slope.

Banned substance

Anyway, it feels to me like the PPI scandal infused the UK consumer of financial products with a compensation culture mindset.

Barely a week goes by now without something labelled ‘the next PPI’.

Indeed, avoiding ‘the next PPI’ has probably already helped restrict what products we have today.

  • The Order Book for Retail Bonds launched with great fanfare a decade ago as a way for ordinary investors to buy higher-yielding company bonds directly. It’s now moribund. Mostly that’s because cheaper funding became available elsewhere. But I suspect corporations also decided they could do without the hassle of retail investors.
  • Riskier mini bonds have effectively been regulated away. You might say good riddance after some blow-ups. But I enjoyed my mini bond portfolio – the higher interest mostly, but also exploring the asset class.
  • A host of factors killed off peer-to-peer investing as originally billed. I think regulation and fear of The Next PPI was in the mix. The big platforms Zopa and Ratesetter had their ups and downs, but overall they allowed enthusiastic users to earn higher interest rates for years. They’re just a shadow of their old selves. Even some readers of this website called them ‘the next PPI’.
  • Whenever a bank threatens to do something with its preference shares, campaigners cite poor pensioners subsisting in blissful ignorance on the dividends. Yet some of these people cried foul at restrictions on retail investors buying new kinds of hybrid bank debt. You live by the sword…

That list is hardly complete, incidentally.

Regulators don’t seem exactly enamored with Innovative Finance ISAs, for instance, which may be one reason they’ve been slow to take off.

And while you’re free to gamble away your life savings at the bookies or online, the checks and restrictions around sticking £50 into a crowdfunded start-up are more rigorous.

Recently the FCA banned the sale of crypto-derivatives, too.

Cry freedom

For sure people don’t require any of those to achieve their financial goals.

But I used some of them – and I certainly liked having the choice.

I don’t dispute a need for some regulation, of course. I can also see that regulators have a very difficult job.

Equity crowdfunding – to take one of my vices – is beset with inflated claims, inadequate markets, scant due diligence, illiquidity, and failure. That’s despite active regulation. You shudder to think of the losses if literally anyone was allowed to say and sell anything to anyone.

But there’s always a danger regulators will go too far. And the cries that go up whenever someone loses some money in some ill-fated venture these days makes it more likely.

For example, there was an episode I remember where it seemed like investment trusts might be accidentally regulated out of retail portfolios.

I even dimly recall a couple of decades ago that dealing in individual shares might have ended up restricted to professionals or other financially sophisticated persons.

Luckily nothing came of it. But don’t be complacent that you’ll always be able to invest in the future like you can currently.

Consider pension freedoms, for instance.

Most people hanging around Monevator are fans of being put in control of their own pension money, obviously.

But we’ve already heard warnings that some people spend their pots too quickly, or that you should have to jump through more hoops to get access to your cash. And that’s in a mostly rising market. Imagine how a big bear market could underwrite that case.

Maybe if you’re forced to convert your index trackers into a derisory annuity when you retire, you’ll sympathize with those of us who don’t like being told we can’t do something because someone else was stupid.

The only way is up

Perhaps the craziest compensation call I’ve heard was that investors in Neil Woodford’s funds should be compensated for the gains they would have made if they’d invested in other, higher-returning products.

The giant can of worms such a precedent would set hardly needs explaining. Yet a few otherwise sensible people nodded along in agreement.

Besides the impracticality and unintended consequences of such a move, it would also cement the growing sense that investing should, apparently, only involve rewards and no risk.

What could you invest in if such a view won the day?

An FSCS protected bank account paying less than 1%, and that’s your lot.

Self-preservation

Regulators do an important job. We don’t want lawless markets.

Regulation around stuff that really kills people – such as debt – is especially important.

I’m pleased regulators will soon regulate ‘Buy Now Pay Later’ firms, too.

But if you’re someone who calls for regulators to swoop down whenever trading gets frothy, on the grounds that people could lose money, please think again.

It took a long time to win the financial independence and options that we enjoy today.

We don’t want our financial lives shepherded back into the hands of advisors, simply due to excessive regulation.





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