“Regulatory capture” is the term for situations where the regulators and the regulated begin to get too close and the regulated industries or organizations begin to indirectly control the actions of the regulator for their own benefit. A topical example would be the sudden, agonized cries of politicians and market regulators for new powers to clamp down on disruptive players like the Redditors or other small investors who triggered the rise in GameStop share prices causing potentially ruinous financial losses for regulated hedge funds.
“GameStop” by JeepersMedia is licensed under CC BY 2.0
Although the story has garnered the attention of regulators and even the White House, the wrong takeaway is to suggest options for retail investors should be restricted more than they already are. Yet this is precisely what William Gavin, Secretary of the Commonwealth of Massachusetts, has called for. Gavin argued that there should be a 30-day trading suspension on GameStop to protect “small and unsophisticated investors.”
Gavin’s suggestion would have serious extended consequences. First, consider the knowledge problem that is involved in constructing such a restrictive regulation. When exactly would a rally become unacceptable? Despite years of decline, Kodak experienced a rally after its announcement that it would move into pharmaceuticals. Would this be permissible? If so, one could simply point to GameStop’s decision to appoint three new directors in an effort to turn the company around. If this is not enough, regulators must clearly state what identified the investments as unacceptable.
It is unclear if there is a perfect benchmark to distinguish rallies. But without such a measure, the suspension proposal would put every rally at risk of wrongful closure — potentially halting the growth of companies and industries, alike. Worse yet, the fear of missing out on a rising stock may push some investors to rush in with less information than they would otherwise acquire. Even if it is in a traditional rally, an uninformed decision could cause more harm than good.
Yet suppose the knowledge problem is solved and there is a perfect measure in place. Should other protections be put in place? One could make the case for a law against allowing “unsophisticated” gamblers from going to Las Vegas and losing money. And although this may seem like a leap, Gavin himself told Reuters, “This isn’t investing, this is gambling,” when he spoke of the GameStop rally.
The rally has attracted the world’s attention, but it does not require it. Rallies are a normal part of financial market activity. The only difference here is that it was Main Street that pulled one over on Wall Street.
