Episode 5 The
problem
with
Stocks

From the moment we’re born, we’re taught that if we want to get rich, we must invest in the stock market. (Looking at you, E*Trade baby!) But what no one teaches us is that the market was built to favor a select few financial firms. The system has only gotten more corrupt as time has gone on, and even as more individuals are investing than ever before, things continue to be wildly unfair.

Read on to stare deep into the dark pools — yes, that’s what they actually call them — and learn how we might go about regulating the market to be fair for everyone.

The Market Is Neither Free Nor Fair

Let's be real: Most people didn’t really pay attention to the inner workings of the stock market until a community of individual investors figured out this system we all obsessively track wasn’t at all transparent or fair. In subreddits and other corners of the internet, these investors realized that hedge funds were shorting certain stocks, including GameStop, and decided to beat them at their own game. They banded together to send the price of GameStop stock through the roof — and in the process they ended up exposing giant faults in the stock market and pushed it to the breaking point. It was big news.

It turns out, though, that the stock shorting stuff is just one piece of a very complex puzzle. As much as we're all aware of the market's daily ups and downs, almost none of us understand what's really going on beneath the surface. That's by design. The financial firms who dominate the market have purposefully built an intricate system of back room trading and money making schemes that are so byzantine that they're nearly impossible to regulate. That makes it easy for the rich to get richer, but it also makes the entire system incredibly fragile.

At this point, the stock market is essentially a casino — except casinos are really well-regulated and cheaters get kicked out.

The math does not add up

The premise behind stocks is simple: People invest money in companies they believe in, and if the companies do well, then they do well. For most of history, however, in order to actually buy stocks you needed a broker to act as the middle man – he took your money and used it to buy you shares in a company. Naturally, the brokers didn’t do this work for free, and this made it almost impossible for most of America to participate in the stock market. Make no mistake, the stock market was an elitist operation from the very first ring of the bell.

[Want to read more on this? Check out Jon's Spotlight on Apple News.]

Obviously this set-up led to significant inequality in the market. The Federal Reserve began analyzing stock ownership in 1989 and found the top 10% of households owned 78% of the market. Eventually, with the dawn of the internet, discount e-brokers like E*Trade emerged and tried to democratize the market. Though this did lead to more people entering the market, the inequality in the market went up right along with it. 

But don’t worry, finally Robinhood came along to save the day! You know the one who steals from the rich and gives to the poor? Well, sort of. This Robinhood was less of a folk hero and more of an app that let people trade with no fees or commissions. So now anyone could invest, no middleman or exorbitant fee needed. Hurrah, now we can all get equally rich! Equal! Rich! Two words that have always gone together!

Would it upset you if we told you that this has only made market inequality worse? Sorry, kid. Even as more and more people are able to trade, giant firms are still the ones who know how to profit the most. This formula seems…. bad. Are we missing something here? Is there a greedy cabal of old white men doing something dastardly behind the curtain? Would it even be America if there wasn’t?

What's Robinhood wearing under those tights?

So now there’s this handy investment app, right there on your smartphone. You’d think, given how we’re led to believe the stock market works, that when you hit the “buy” button on an e-brokerage app like Robinhood, your order would go directly to the stock exchange, your money would then be traded for a share of stock, and then you’d be the proud owner of FUK because you know nothing about stocks but that one made you laugh. But, alas, this is where this story turns dark.

What actually happens the majority of the time when you hit “buy” on the app is called “Payment for Order Flow.” That's when your order and money go to big Wall Street firms called “market makers” — basically middlemen who match buyers to sellers. Citadel and Virtu are two of the biggest market makers. These orders rarely goes to the stock exchange. Instead, market makers match them with other orders they have also already paid for, or they slip these orders into what are called dark pools. What a completely normal and not at all terrifying thing to call something.

Market makers pay Robinhood and other trading platforms a ton of money for the privilege of doing this matchmaking, and would you believe they’re not doing this out of the goodness of their heart? They’ve said it’s because they want to keep the market democratized, but here’s the reality: Payment for Order Flow allows market makers to use the small differences between the price a stock is bought and sold for to make pennies off of every transaction they process.

This doesn’t sound like a big deal, but when you consider the gazillions of transactions they’re processing, you realize that actually a gazillion pennies is quite a lot of money.

This scheme is already illegal in many other countries, and there's a push to outlaw it in the U.S., but for the moment, it’s perfectly legal. Now we see why the rich men in charge want a “democratized” market: The more people who are trading, the more money they can make off of them. 

The resistance emerges... on Reddit?

It's time to talk about the apes — that's an acronym for All People Equal, if you're wondering. They're the community of Reddit users who started the GameStop stock buying frenzy. You can read more about their ingenious and slightly terrifying plan right here. It all worked a little TOO well. So well that one day Robinhood suddenly stopped allowing users to buy GameStop stock. This move was deeply sus, if you ask pretty much anyone who is not Robinhood.

For their part, Robinhood said they’d gotten a call from their clearinghouse. OK, yes, but other people were suspicious for a couple of reasons, one being the fact that a hedge fund called Melvin Capital, which lost billions in the GameStop frenzy, got an investment/bailout from... Citadel hedge fund, the totally unrelated hedge fund owned by the same people who own Citadel Securities, which is the Payment for Order Flow company that handles Robinhood’s orders.

What happens with an extremely complex system is that it leads naturally to this level of inequality and this level of exploitation, because a few firms who are big enough can take advantage of that complexity.

Panelist Dave Lauer

Meet our panelists

How do we un-break the market?

The stock market right now is a bigger mess than the Starbucks counter where the milk is. (Why can’t people ever get the cinnamon in their cup?) We’ve got exceedingly wealthy firms setting their own rules and treating retail investors as “dumb money” that can be exploited for their gain. Doesn’t feel great, right? 

Let’s start with the Securities and Exchange Commission, aka the SEC, the government body that regulates and monitors the stock market and the investors and firms that participate in it. In theory, the SEC is there to create regulations that protect investors and make sure they’re not getting screwed over (*ahem* Payment for Order Flow), as we saw in Jon’s interview with current SEC chairman Gary Gensler in this episode, they’re in a very tough spot. 

As Jon put it, they’re the sheriff and they’re outgunned. They don’t have enough resources, and they definitely can’t keep pace with the technological advancements that are happening constantly in the financial industry. We've got a deeper dive on the many issues standing in the way of the SEC right here for you.

What to do

So, how do we make it less challenging to keep this greedy band of Wall Street bros in check? Here’s a summary of what came out of our conversations. If you want to go whole hog, click here for our Take Action page.

Crowdsourcing corruption busting

Organized rebellion, like the GameStop stock surge, has shown that retail investors are far from “dumb money” — they’re actually smart enough to bring the entire system to its knees. But let’s be real: While their success is inspiring, it shouldn’t be entirely on the apes of Reddit to reform our market one meme stock at a time. Still, there is a role for retail investors to play: grassroots power can be used to hold firms accountable. We can demand that firms aren’t able to exploit the market and we can press Congress and other government bodies to properly regulate it.

Show everybody everything

Our panelist J Brown made the point that in order for things to be fair, retail investors need to have access to the same information that the firms dominating the market have. There shouldn’t be off-exchange trading that’s out of view from your average person. Politicians shouldn’t be able to trade stocks based on information they appear to have special access to. Seems basic, but it still happens.

Reform! Reform! Reform!

As Dave Lauer outlined on our panel, the structure of the market is ultra complex, and that’s by design. The more obscured things are by complexity, the harder they are to regulate. And to make matters worse, at the moment many of the rules that are in place are “self-regulatory,” meaning these institutions are meant to keep themselves in check. Really flawless plan. It’s working like an absolute charm, clearly.

Lauer is leading a grassroots campaign called We The Investor to mobilize investors and push Congress and the SEC to fix our extremely rickety market structure and bad practices like Payment for Order Flow. There are also nonprofit organizations like Better Markets that push for financial reforms that will make the market fairer for everyone.

Better Markets

More money for enforcement

Something that came up in our interview with Gary Gensler and also on the podcast with Rob Jackson is that the SEC needs more resources to function at maximum efficiency. You can have as many rules in place as you want, but they’re useless unless someone is able to enforce them. They could especially use a boost in funds when it comes to keeping up with the technology needed to effectively police the firms that are constantly evolving. A beefed up SEC would also make it easier for retail investors to interact with them. The decision to give the SEC more money is one Congress has to make.

Waaaaay less money on lobbying

There’s a big, honking reason why Congress is very resistant to making the SEC a more powerful agency, and — no surprise!— it’s that Big Finance spends an incredible amount of money lobbying them to keep regulations to a minimum. In 2020, Wall Street spent almost $3 billion on campaigns and lobbying efforts. It’s often called the Acela Economy, because it runs between Wall Street and D.C. Basically lawyers move in and out of working at the SEC and representing financial firms, both defending them and lobbying them. 

Disclosure of the amount of money that is spent influencing members of Congress is possible to find buried in records, but you basically need the digging skills of a journalist to do it. This means your average investor likely has no idea how much money a given company has contributed to PACs or spent lobbying this committee chairman or that one. So this, too, is much needed transparency. And would be relatively easy to make into law, since this information could be easily published in a firm’s annual report — if only members of Congress would vote for it...

No more trading stonky bois for those in charge!

A final, *crucial* wrinkle here that needs to be ironed out is that members of Congress, people who work at the Fed, and even the SEC commissioner are freely allowed to trade stocks while in office. Rob Jackson learned that one firsthand when he took the job and was flabbergasted to hear that he was fully allowed to trade stocks WHILE HE WAS IN CHARGE OF POLICING THEM as long as he disclosed it later. 

Members of Congress and their spouses are also frequent stock traders. They’re supposed to disclose these trades quickly, but they often do not comply with the rules. Sen. Dianne Feinstein (D-CA) took months to disclose her husband bought five figures worth of stock in a polling company. Sen. Rand Paul (R-KY) waited a whopping 16 months to disclose that his wife bought stock in a pharmaceutical company that made a treatment for COVID-19.

There is actually a law that House Democrats are currently drafting that would ban stock trading for members, and there are several similar bills in the Senate as well. While the specifics on what it would prohibit aren’t yet determined, there is a chance it could pass by the end of the year. Assuming it has some teeth, that would be a great start to making the regulatory system less corrupt.

We can all win if some of us stop cheating

As J Brown emphasized repeatedly during our panel, this isn’t a case of one side losing so the other can win. Rob Jackson explained on the podcast that the current mindset in D.C. and in the financial industry is that you can’t have investor protection AND grow capital. But that’s simply not true. We can have both! 

But that won’t happen as long as those who are making fucktons of money (yes, that’s an exact amount) by keeping the market unfair are in charge of the rules and policing themselves. What we need is for everyone in the market to work together to make the entire system better for everyone. Oh, and if anyone replies that Crypto will save us, we will call the police.

Funny shit