SPENCER JAKAB | From The Wall Street Journal

If you don't know who the sucker is at the poker table it's you. I was joined in this conversation by Wall Street Journal reporter Spencer Jakab. His latest book is “The Revolution That Wasn’t: GameStop, Reddit and the Fleecing of Small Investors.” The frenzy in meme stocks in 2021 was perceived as a Robin Hood style raid on Wall Street. Reddit forums filled with young men holding "diamond hands" taking down the financial industry. The truth was far more nuanced.

We also took a detour to look at insider trading by members of Congress.

Spencer Jakab writes for and edits the Heard on the Street Column at The Wall Street Journal. He was Deputy Editor between 2015 and 2019 and wrote the Journal’s daily investing column, Ahead of the Tape, for four years before that.

Spencer spent four years at Britain’s Financial Times writing the “Lex” and “On Wall Street” columns and got his start in financial journalism at Dow Jones Newswires where he was part of a SABEW-winning team covering energy markets.

Spencer is the author of two books on the plight of individual investors, both published by the Portfolio imprint of Penguin Random House. “Heads I Win, Tails I Win: Why Smart Investors Fail and How To Tilt the Odds in Your Favor” (2016) and “The Revolution That Wasn’t: GameStop, Reddit and the Fleecing of Small Investors.”

His first career was in finance where he spent years as a top-rated emerging market stock analyst. He lives in New Jersey with his wife and three sons.

Spencer Jakab in conversation with Jon Stewart

TRANSCRIPT FOLLOWS AFTER THIS BRIEF MESSAGE

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EPISODE TRANSCRIPT

Spencer Jakab is the editor of the Heard on the Street Column in the Wall Street Journal and the author of "The Revolution That Wasn't - Game Stop, Reddit and the Fleecing of Small Investors". Tell us a bit about your background in finance before you pivoted into journalism because journalism wasn't your first profession, was it?

Spencer (1m 16s):
No, it wasn't. No. I spent almost the first decade of my professional life working in finance. I was an emerging markets analyst and rose very quickly in that world and, and became head of research for large swath of emerging markets at it was then called CS First Boston, it's now Credit Suisse investment bank. So through the nineties and, and early oughts, I fell into that by accident. To be honest, I was really looking to do something more cerebral and contemplative, and then ran into somebody who, who had a guy who was a friend of mine still, who had been an investment banker and had intrigued me. And I asked him what I would need to do to be an investment banker. My parents were poor immigrants in their, their twenties and no one that they knew had, had worked on wall street.

Spencer (1m 59s):
Even though I grew up in New York city, I grew up in a different part of New York city than Wall Street. And, and he told me, well, just take all of the, the finance classes. We were at a, a program at Columbia University at Columbia business school, finance and accounting we were allowed to do that back then. And I liked the subject and it led to a, a job working in, in Europe for, for CS first Boston. And it, it was fun for the, the first few years. And then, you know, the more senior I got, the more, it was about managing people. The more it was about marketing and, and just going to lots and lots of meetings and saying the same thing over and over again, I got a good insight into that world, but I didn't wanna do it forever. And, you know, thought that it was very interesting.

Spencer (2m 39s):
I'd love to write about it and talk to people about it. If only there was some career that would allow me to do that, and I'd become very good friends with a guy who's my age, same exact background as me, you know, parents, you know, came from the same place and he had gone to Columbia journalism school that's where we had met. And I asked him about what, what he thought about me applying at that, that age, I guess I was 33 to journalism school. And he said, no, don't bother because you, you already know something. You already know something very useful if you wanna be a financial journalist. So why don't you just go out and try to get a job? And I, I think somebody will hire you. And it was good advice. I wound up sitting on an airplane next to a reporter from the Wall Street Journal, who, you know, had been a big star and was just managing an office in, in London for them.

Spencer (3m 22s):
One thing led to another, within two days, I basically had taken a writing test and gotten a job offer and, and taken a gigantic pay cut to become a journalist. And that was, that was 20 years ago. So, and, and I've, I've been doing that ever since different roles, but mainly writing commentary financial commentary, which is what I do now.

Phil (3m 40s):
It's interesting. You used the word previously contemplative. It's not something you sort of think about with journalism these days, cuz everything is about memes and the fast moving issues happening on social media. Well,

Spencer (3m 52s):
It, it, I guess it is. I mean, it's, you know, social media definitely journalism has, has changed. It's become much quicker, you know, back when I was at, at the investment bank and you'd show up at the meeting in the morning at, at six 30 or 6 45 in the morning, you know, kind of dark outside. And you were talking about what were you going to talk to clients about that day? And that was in London. You weren't expected to have read the entire newspaper. Of course, by the time you got in and this, this was in an era before you could read anything on the internet or that I even had heard the word internet, I guess when I first got started in the job, but you, you needed to have read the Lex column at the Financial Times, which is a column very much like the one that I run. As a matter of fact, I, I went to the Financial Times and I wrote for the Lex column and edited for the Lex column for four years before coming back to the journal a decade ago, I was like, wow, that's, you know, if they, in 400 words or 500 words can say so much more than we can say in a 10 page report, I would love to be able to, to communicate that way.

Spencer (4m 50s):
And so it, it still is the case, but financial journalism and financial commentary has changed because you know, you have a million people out there spewing their opinions. You have Seeking Alpha, you have blogs and you know, you have all kinds of people with substacks and what have you. And so it's, it's a much more crowded sphere in terms of commentary. And so, you know, it used to be, I mean, I, I also wrote several pieces for Baron's magazine when I was getting my start and every fund manager who's worth his salt would over the weekend read Baron's magazine because on Monday morning shares would go up or down based on what Barons had had said. And, you know, I was so happy to, you know, get the chance to write several columns and features for barons.

Spencer (5m 30s):
You know, when I got my start as a journalist, but it no longer really has that effect. You know, unless you have said something that's completely unique, uncovered some kind of a scandal. And even then sometimes stocks don't move the way they used to. So I guess you don't have the satisfaction of being this sort of this very, very powerful, unique voice, but you can still do the same kind of work. And, and I like it a lot. And I, today I, I write less frequently. Of course I wrote this book, but I edit this team of, of 14 people and, and I really love doing it

Phil (5m 60s):
Well, let's move onto the book, the Game Stop saga, which seems so long ago now, can you give us a brief rundown about what happened?

Spencer (6m 7s):
Sure. Well, what happened is obviously the, the events that I, that described all happened the space of seven to 10 days, but really the story goes back a couple of years and, and goes ahead of that. And what happened was that you had a tiny little company that was a mall based retailer of video games. It was. And I, I don't know if you, you have this everywhere, people listening to this, but blockbuster video. Blockbuster was a ubiquitous chain in the United States where you'd go and rent, video cassettes and, and later DVDs, you know, when people had devices in their homes and that was the main way they watch movies. And then as films became digitized, it said it could fight on.

Spencer (6m 50s):
And, you know, we kind of belittled Netflix and the others, but Netflix put it out business. It, it digitized it outta business basically. And blockbuster tried very, very late to digitize itself, but it, you know, it just, you know, was woefully too late. It went bankrupt and this company was very often compared to blockbuster, game stop was. And so it was, it was worth at the time that people started paying attention to it for reasons other than being kind of a money losing slowly, going on a business retailer worth about 210 million us dollars, but it became the most traded security on earth. It almost destabilized the us financial system.

Spencer (7m 29s):
It became the most searched term on earth, became a point of obsession for about 8 million, mostly young, mostly male people who not only thought that it would go up. And it did go up about by about a thousand percent. Stocks do go up a lot sometimes for silly reasons, but they wanted to use it to bankrupt certain firms on wall street. And they cost those firms billions and billions of dollars by identifying a vulnerability. And when it was brought to my attention. So I, I have three boys game stop is a very familiar company to me, not only because I had written about it many times in the past and edited many columns about it, it was getting obviously off of my radar because it was so small and money losing and inconsequential.

Spencer (8m 13s):
But because I have three boys and I, I had taken them there so many times. And you know, I think the first time that I, I took my oldest boy there, he's probably four or five years old. He's 23 years old now, but we visited a lot and he came over to me. He was home for, for this is January. And he said, Hey, dad, are you write something about, and he's not usually too interested in what I'm I'm writing about. I was surprised that he asked, I took a look at game, stop pulled up. The ticker at GME saw that it had doubled in the last two days, like, wow, what's going on? He told me that a friend of his had bought it a few days ago and it doubled his money. And that they're talking about it on wall street bets.

Spencer (8m 53s):
Wall street bets is one of about a hundred thousand thousand subreddits. Subreddits are forums on Reddit, the social media forum, where you talk about all kinds of things. People talk about dogs. People talk about bicycling. People talk about running weight loss. What have you. And they talk about investing in, in several different forums. Wall street bets was one that had come to my attention about a year before that, because all of a sudden you had all these people who were at home board, apes board, apes, exactly. With, with not, not, not too much to do. And you had this flood of about 10 to 12 million just in the United States, young people who had opened up brokerage accounts, which could be opened, you know, recent developments that allowed this to happen with very little money.

Spencer (9m 39s):
You could, even, if you didn't have enough money to buy a single share of a stock, you could buy a fraction of a share of a stock pay $0 commission. And it, it had become the funnest game in town. And so every week or so you would see basically that, you know, people discussing some stock on wall street bets, and maybe for an hour or half a day or a day or two days, including companies that were already bankrupt and worthless, they would go up, they would double or triple or whatever. And it was the kind of thing that we, we could have laughed at, you know, in, in the newsroom at the wall street journal. And then later when we were sent home, this started slightly before the pandemic, when trading had become free in late 2019 at every stock broker in the us. And it wasn't really free.

Spencer (10m 19s):
I'll discuss that later. But, and so I, I told him like, you know, and this, I knew the kid who he was talking about. I said, I, I think I'm not gonna use his name here. But I said, I think he should probably sell this. I've seen this happen a bunch of times before, and it's great that he doubled his money, but you know, you don't know how long these things last. And I wouldn't push my luck because game stop is almost a worthless company. And it was probably, you know, had gone up fivefold or tenfold by that point, as it had been going up for a while, I didn't really know why then. And what he told me was, no, he won't sell. And so can't sell, won't sell. What does that mean? And what was different about this was that all these people on this board had kind of banded together and pledged to have diamond hands not to sell this stock because they had identified the vulnerability that was out there, where you had a bunch of hedge funds that had sold the stock short.

Spencer (11m 11s):
And just for your audience who doesn't know this selling a stock short is the opposite of what most people do, which is they bet that a stock will go down rather than it'll go up. It's totally legitimate practice. There's nothing nefarious about it. Although it's often portrayed that way, but the primary way to, to do it exposes you in theory to an unlimited loss, because when you or I buy a fund or a stock, the worst thing that can happen is that it goes to zero and we lose all our money. You can't lose more than all of your money, but when you bet against a stock, you sell it without owning it. Somebody says, yes, I'm lending it to you. Now you can sell it. And you sell that, that share of stock to somebody, and then they buy it. They don't know who sold it to them.

Spencer (11m 52s):
They don't know that it was a short seller. And then if the stock starts to go up and it goes up a lot, well, it can go up to infinity in theory, right? So your losses are also in infinite, whereas your, your gains are capped at 100%. The most it could do is go to zero and they'd identified. This is basically the most wagered against stock wagered against to the extent that if someone were to snap up all the shares, it would be impossible to buy back all the stock. Now, this used to happen about a hundred years before that in the 1920s, that was the last time that this was possible to do, but there were so-called stock market corners where someone would sneak up on people who had sold a stock short buy up more than the shares available.

Spencer (12m 33s):
And then say, you have to pay us some insane amount of money, short of you going bankrupt, or maybe even making go BA go bankrupt. You, you could do it. You know, at, in that day, surreptitiously. With modern securities laws, it's impossible to do because it's illegal to do that. But what these people had done was legal, which was to discuss on an open forum across several weeks. I was reading all the messages my jaw dropped and they sought to bankrupt these hedge funds and the hedge funds just didn't take this board seriously. They didn't bother reading it. They didn't take it seriously. Some of them actually did read it and laughed at it. Taunted these people openly told them they didn't know what they were doing, that they were the suckers at the poker table. I'm quoting directly one very well known short seller, and lo and behold, they lost billions of dollars.

Spencer (13m 18s):
And the people who were doing this kept pushing it and pushing it and pushing it. And that that's the stage at which I became aware of the story. The newspaper articles started to appear within hours of my realizing it, I, I think I sent a, an email to the acquisitions editor at penguin random house immediately, like within 10 minutes of seeing this, because I knew that it would be a big story and it turned into an even bigger story than I imagined because it turned into a conspiracy theory and it became, you know, the most search term, as I said, it, there were congressional hearings. And even today the recriminations remain for the story. So it is the, probably the craziest financial story of my career.

Spencer (13m 58s):
And I'm, I'm so glad that I kind of jumped on it at the time and saw it for what it was, because, you know, a lot of other people wanted to write books about it too. And you know, there only so many publishers who wanted to publish a book about it. So I, I tried to tell the story and I, I think I tell the crazy story, but I, I tell it in a way that, you know, I I'm thinking of, of an educated reader who doesn't know a lot about finance. So there are people in finance who read it and said, you know, I, I actually learned a lot reading this book. You know, you really do a very good job of explaining the kind of nuances of what they were doing. But then a lot of people who don't know anything about finance, so just educated people. And I was thinking of, you know, my mom or my wife, or my sister, or my, my friends who don't work in finance, how do I write this in a way that explains the story that they've all heard about on TV, but explains it in the correct context because the, you know, the, the articles came and went.

Spencer (14m 51s):
It was the most written, there were about 1,100 articles just in the English speaking world about it that week. And then it kind of faded from the headlines and that the headlines that initially came out and the, the reason that I call it, the revolution that wasn't is that they were written in a way that portrayed it as this kind of black eye, this victory over wall street. And, and that's actually not what it was. And I've been covering wall street for long enough to tell you that the people who really made money off of this and that they were almost embarrassed by it, in some cases were already wealthy people. There are people who work on wall street and people who were shareholders of these companies work in corporate boardrooms. And there are a lot of people who were not ashamed of taking advantage of it, who basically milked it for all it was worth.

Spencer (15m 35s):
And even today continue to milk it for what all it is worth because the story continues to reverberate today, enrich people.

Phil (15m 46s):
Well, let's talk about that aspect because a lot of the ideas behind it were that it was a people's movement that we can get one up on wall street. We could stick it to the man and I'm, I'm presuming that's why you call it the revolution that wasn't, it wasn't actually a revolution that wall street still won in the end.

Spencer (16m 4s):
It did. And, and so, and as you know, as you said in your introduction, you know, wall street is a big place. The world of finance is a big place and the world of finance is mostly made up you know, you, you see these movies or you watch the show billions, or you watch the movie wall street, and you think about it as this place filled with swashbuckling risk takers, but they are to the extent that people take risks on wall street, professional wall street,

Phil (16m 31s):
In expensive suits,

Spencer (16m 32s):
In expensive suits, they are taking risks with other people's money. Of course, they're smart and sophisticated. Most of them, they have good computers and, and whatever, and they're, they're competing with each other, but they're using your money. They're using an endowments money or an individual's money to compete with one another. And it's a zero sum game. And it's actually a less than zero sum game in the sense that they will, will fight over the returns in this market. But the returns of the market are basically determined by what happens in the economy and because they charge fees. And because what they do is expensive, the amount that they return to you in aggregate, of course, you may have, you know, picked a winning horse, but the amount that they return to you in aggregate as a saver is gonna be a little bit less and sometimes a lot less than that general return in the economy.

Spencer (17m 20s):
And most of wall street actually is made up of people who don't take any risk with anybody's money. They're basically middle men. And both of those types of people did really, really well. In this episode, I'm talking about people who trade trade, the stocks, people who process the orders, all the people who are kind of behind the scenes that make this, this wonderful world of personal finance possible. It is a very, very lucrative, profitable world. I work in Midtown Manhattan. I took a, as I said, I took a huge pay cut to be in this world of financial journalism rather than finance. But, you know, if I have an expense account to take someone out a restaurant in Midtown, it's filled every day with people in suits, selling each other stuff, you know, and who's paying for all those steak dinners and steak lunches.

Spencer (18m 6s):
Well, it's you, the person who entrusted your money to these people in a very indirect way, of course, but you're, you're paying for it. And that's what people have to understand. And it's what the, the people who, who did this do not understand. They, they saw it as a big victory over wall street. To them Wall street is some guy who lost 7 billion. Well, you know what? He not lose 7 billion. Gabe Plotkin who I, you know, is one of the kind of heroes or anti heroes on my story. His investors lost 7 billion. And you know, what? The investors in someone else's fund made a lot of money. And there were a whole bunch of funds that had a windfall as a result. And there were a bunch of billionaires who added to their stacks of money as a result of this episode and all of the speculative frenzy that came before and after it, and that made it possible.

Spencer (18m 56s):
And the most fascinating thing about the story is not the fact that people kind of continue to kind of delude themselves about sort of being able to kind of beat wall street. And of course there were individuals, you know, Phil, I mean, who, who, who win I'm, I'm not, that's not what I'm saying. There, there are people who walk away with more money than they came in with. I I'm under no illusion that, that people didn't do well out of this who are individuals. And I hope that they kept it, but the most interesting thing about this is all the things in socially and economically, and in terms of the finance industry that had to fall into place. And in terms of the pandemic for this to happen, it was really a perfect storm that allowed the situation to happen. And one of the, the sort of the, the, the main people I write about Vlad Tenev, who runs this brokerage firm, Robinhood was dragged in front of Congress to explain the episode.

Spencer (19m 44s):
And it's, you know, he's a mathematician actually. And he said, by my calculations, this was a black Swan event. And it had a one in 3.5 million chance of happening, which means it should not have happened in the history of, I don't know of, of man. Well, I, I don't know if his calculations are correct, but many things have to fall in place for this crazy story to happen. It probably won't ha repeat itself in the same way again, ever. And it's very, very interesting. It tells you a lot about American society, about wealth inequality, about wall street. And, and so that's, that's the story that I, I really endeavor to tell, not just the, kind of the crazy happenings

Phil (20m 21s):
And, and that's an interesting aspect of the book and is that there's a lot of people from a certain generation who saw their parents lose a lot of money during the GFC. And this was one of the, the ways that they felt they could get back at the people who caused such problems for their families.

Spencer (20m 40s):
Yes, absolutely. That that is a big part of it is that the generation that for the most part participated in this were probably 70 to 80% male based on, you know, various bits of, of data. I have, although possibly as much as 90%, they were between the ages of 18 and 35. So basically during the, the global financial crisis, when their parents or their parents' friends were losing their homes or their jobs, or their nest eggs, they were too young to be participating in finance, but they formed this, not a resentment of wealth, but a resentment of wall street specifically. So there are rich people in this story who are seen as heroes by this crowd, Elon Musk, a man named Chamath Palihapitiya, a man named Dave Portnoy who are millionaires or billionaires who were lionized as being on our side.

Spencer (21m 30s):
And with us, it was people who put on suits and go to offices on wall street. And especially people who are short sellers because short sellers are Al have always really been vilified. It's seen as a sort of predatory kind of thing to bet that a stock or a market will go down. And so they were the sort of the real cartoon villains in, in the minds of, of this group and in their minds, they, they defeated wall street. They won wall street lost not, it's not exactly the way it happened, but yes, that the GFC really kind of laid the seeds of resentment that fueled this for sure. And

Phil (22m 6s):
I know that you don't particularly feel that short sellers are evil as such, but that they do play an important role, especially in price discovery.

Spencer (22m 16s):
Yeah. I mean that, that's, that's one of the ironies here. Short sellers have always been a useful and sometimes necessary part of markets. I mean, think about it this way. You know, you are relatively inexperienced retail investor, and instead of buying an index fund, you wanna buy an individual stock and somebody tells you about Acme incorporated, right? In the absence of short selling, two ways to vote on Acme. You take a look at Acme and you say, yes, I'll buy it. Or you say, no, I'm going to abstain and not buy it. There's no, I'm gonna bet against it. I think Acme is too expensive, but of course at any given time, about half or sometimes more than half of stocks on the market are too expensive, are not going to do well.

Spencer (22m 57s):
As a matter of fact, over any 10 year period, about 85% of stocks will not beat the market. It is a, a minority of stocks that will beat the market. And about half of stocks will perform catastrophically over any longer period of time. So it's not a silly thing to bet against stocks. You are betting against a generally rising trend. Of course, markets do rise over time. But what short sellers are doing is picking their spots and saying, I think this is too expensive. Or maybe this is a company called Enron is a, a fraud in my opinion. And I'm going to bet against it. And as I said, they're taking this extreme risk because if it goes against them, even if it temporarily goes against them, it can cost them everything.

Spencer (23m 39s):
So, you know, short sellers, they're not too many dedicated short sellers anymore because it's seen as such a, a dangerous profession. As a matter of fact, you know, when there are dedicated, short selling funds out there, those funds generally are patronized by investors who generally hope the stock market will rise. They're not betting against society, not betting on the, the kind of collapse of civilization, but may, maybe they'll have 95% of their money, you know, betting on various stock indices and companies. And they'll say, you know what, I'm gonna put 5% in this short fund, because that will smooth out my returns. If there's something really bad happens, then that fund is gonna go up when all these other funds go down and that fund might go up a lot.

Spencer (24m 22s):
When all these other funds go down and that owning some of that fund helps me sleep at night and helps me be invested in the market. And short sellers provide liquidity because when, you know, when markets go up, they help in, in the buying, when markets go down, you know, they they're, they're there on both sides. And I think people don't, you know, who, who don't understand the mechanics of markets say, why would I like someone who's BA basically betting against what I'm hoping for? Which is that stocks go up and pay dividends and make me rich, but they are a necessary part. Just like, you know, it's like, I don't like ants. I don't like worms. I mean that, you know, just to use some of the things that they're they're compared to, if there are no ants, we'd have no, you know, no crops or worms or whatever.

Spencer (25m 4s):
I mean, you know, they're, they're there bees, if there are no, I don't like bees, bees sting me, like, you know, we'd have no crops if there were no bees. I mean, and not, I'm not one to call them vermin or insects or something, but that that's kind of the role they play. You know, if you didn't have short sellers, markets would be less, less good place for you. The individual.

Phil (25m 23s):
So you've mentioned Robin hood and the role of free brokerage is two aspects that played into this scenario. Tell us about that. How can they offer free brokerage? For example?

Spencer (25m 33s):
Well, the two gentlemen who started Robinhood and they were not the first people to do this, but they were the first people to do it successfully and profitably. They got their start, actually helping hedge funds, trade all the, sort of the mechanics of setting up computerized trading. And today, you know, you think of a stock exchange as a bunch of guys and funny shirts running around. But stock exchanges basically are just big computer banks located in not very glamorous places like outside Kansas city or in New Jersey, across the river from New York and stuff like that. They're, they're gigantic server farms and they helped hedge funds trade. And they noticed that hedge funds paid not nothing, cuz you can't do it for nothing but pretty close to nothing to trade.

Spencer (26m 17s):
They said, Hey, why can't we do this for individuals? So the first thing they said about doing, they started this company called Robinhood and before they figured out how to do it, they knew that they could, they could do the free trading part, but what they had to do was to get customers. And so they spent a couple of years building an app and they were near Stanford university, which was a university in California and they built this app and they kept bringing versions of it to a cafe near Stanford and they showed it to people. And how do you like this? How do you like that? And they basically saw what young people and they knew that they were gonna aim it at young people, people sort of, you know, 20, 21, 22 years old who were just getting their start financially. What do you think about this?

Spencer (26m 57s):
And in 2015, they came out with the app. It was named app of the year in the apple app store. It is a thing of beauty and not in all necessarily in a good way either, but it's a very, very smooth, very S slick, very functional app. So word of the app had leaked and there was an article about it in site called hacker news. And it went viral on hacker news. And by the time they actually were ready with the app, they had about a million people on a waiting list and they actually turned the waiting list to do game. You are number 394,865 in the waiting list. You know, sign up your friends. They had a million people waiting for this thing that didn't yet exist. And then people signed up and they were allowed to trade for free.

Spencer (27m 39s):
Well, how you ask, can you trade for free? The way that you could trade for free is like in the United States. And this doesn't is not the case in, in every country, in the UK and Canada, for example, you can't do it, but some countries you can and the us is the, the pioneer of this. You have something called payment for order flow. So you have, you actually have 15 stock exchanges give or take in the United States, stock exchanges where you send an order. And even though you can't see your order go through, you know, that one of those orders that you saw go through was your order to buy or sell a share. And it got executed by a computer probably rather than a person, but it was there somewhere that's called a lit exchange, but what you have in the United States, and this is not really this, this has been the, the subject of a lot of conspiracy theories.

Spencer (28m 23s):
It's not so necessarily nefarious called payment for order flow where these firms that say, no, don't send it to a stock exchange. We'll give you as good of a price or maybe even better than a stock exchange and we'll fill it. We're not gonna tell you how we fill it, but we're gonna fill that order. And the way they fill it is basically replicating a stock exchange just to have a gigantic computerized black box, where they have their own money and they're matching up orders and they're buying here and selling there. And then in nanoseconds, they're splitting it up and they're shaving a fraction of a penny off of it for themselves. The biggest of these black boxes in the, the year leading up to this was called Citadel securities. And they had revenue of in excess of 6 billion.

Spencer (29m 6s):
They had pretax profit of in excess of 4 billion. That's not something they wanted to know. It, it happened to leak out that they made that much money doing this. So those fractions of a penny really do add up. This was during the pandemic year, this was during 2020 when the pandemic arrived markets crashed. And you had an explosion in trading 2021 we don't know because that, that number did not leak. It was probably also a really good year, probably even better because that year encompasses the kind of the apex of this speculative mania that, that sent game stop and the other meme stocks surging, and there were a whole bunch of other firms there to Susquehanna, Wolverine trading. And what have you that were smaller players in this and what those firms do?

Spencer (29m 47s):
The reason that they're important to this story is that they made Robinhood possible. They made $0 trades possible. So Robinhood over a period of about five years, their customers were all small, but one out of every two brokerage accounts opened in the United States were opened at this tiny broker called Robinhood. You have these much, much bigger companies, long established companies, Charles Schwab and fidelity E-Trade Ameritrade Merrill Lynch, Morgan Stanley, you know, names that you've heard of before that were just having their lunch. And the customers that that Robinhood was getting were very, very small for the most part. The median account size was $241, but still it was a lot of people.

Spencer (30m 29s):
It was millions of people joining Robinhood. And finally in late 2019 Charles Schwab, which was really big firm with much richer customers threw in the towel and said, okay, if you can't beat them, join them. We'll also have $0 commissions. And we'll also, you know, get paid this way. And it didn't matter as much for them because those companies make money In a lot of other ways, they have a retirement account for you. They have a credit card for you. They have a bank account for you. They have, you know, a person who will talk to you for money and advise you and all kinds of other services. And so they're like, well, this is gonna be costly, but we've gotta do it but much to their surprise. Their business is exploded as a result of cutting the cost to zero.

Spencer (31m 9s):
And that is because of something they should have known about called the zero price effect. Zero price effect is if you take something that happens to be fun and it doesn't matter how much it costs. If you take that thing, whether it cost a hundred dollars or $1 and you cut it to zero, you tell people it's free. They're gonna do it a lot. They're gonna use a lot of it a lot more than they did when it cost something. And what they didn't realize is the thing that they were selling in 2020 at least was fun. Trading stocks was fun. People were home. This is even before the pandemic began, but then especially after the pandemic began, it became like a, you know, there was this, this explosion in speculation in stock trading because the markets were wild.

Spencer (31m 50s):
It becomes like sports betting. Doesn't it, it becomes like sports betting and sports betting in the United States happened to be illegal in most places. Other than if you physically went to Las Vegas until 2018. And there was a seminal Supreme court case that allowed it to be legalized. And so 2018, 2019, 2020 state by state, by state, it was allowed. And it was being done primarily unlike other forms of, of gambling, it was being done by young men, young people. It, it, it, it was inversely correlated with age. You had all these young men. I told you I have three young men in my family. Two of whom are old enough to do this. They don't, but I can see that their friends do it and their friends are all over this.

Spencer (32m 30s):
Just wasting time and money. In my opinion, betting on sports all the time. It was like a, the fun. You didn't have to commit much money to it or much brain power. And they didn't have much of both in some cases, but you know, they, they loved doing it, but all sports went away in March, 2020. The most gambled upon sporting event in fact was about to start, which is the NCAA men's basketball tournament. It's the most waged upon event in the United States in aggregate this gigantic basketball tournament that people's productivity, plummets, you know, even, you know, I, everyone bets on it, you know, I mean, that's the one thing that I bet on I'll bet like $5 on it, you know, and everyone has an office pool and, and you're watching these teams that you've never even seen before because you have money riding on it and then a big prize in your office.

Spencer (33m 18s):
And that went, I, and people were home and bored. Young people had extra money because they got stimulus checks. They had extra money because young people, as you probably know, they tend to spend money as soon as they make it, all of a sudden they had nothing to spend money on. You couldn't go out to a bar. You couldn't go to a restaurant. You couldn't go out with your friends, but your paycheck was still coming in probably. Or you got an unemployment check and then you got a stimulus check on top of that. So you had more cash than you probably ever had had. Wasn't a tremendous fortune, but a thousand dollars is, is a nice chunk of change and nothing to spend it on. And your friends were telling you about this fun new game called the stock market. And there were all these influencers who were popping up on TikTok and on YouTube and on Twitter and Facebook telling you how to invest your money.

Spencer (34m 4s):
Some of them had about a month more experience than you did in the stock market. And they were making small fortunes becoming influencers or influencers as they called themselves. And, and so it was this, this perfect social moment for an explosion. And so you had the dumbest things going on, and then you had people let's say like me, like Warren Buffett, not that I'm like Warren Buffett, but people who sort of have a few gray hairs and, you know, sober and saying, Hey, you know, this, this is not that smart. You just bought shares in the bankrupt company. And they're like, oh yeah, the shares in that bankrupt company just doubled like, well, okay. But then somebody has to buy that from, you know, it was just all in the greater fool theory. Like they would buy shares of worthless companies, companies that were proposing all kinds of ludicrous things, right.

Spencer (34m 49s):
And those were the, the hottest stocks from the bottom of the stock market in March, 2020 through the next February an index of technology companies that made no profits went up by 420%. It was the best thing to buy.

Phil (35m 5s):
Is there a silver lining out of all this, that people's interest in investing has been piqmed and they would possibly a percentage of them would sort of look at what's going on and going well, yeah, maybe it is a Mugs game and maybe it's a fool's game. And how could we perhaps start learning about investing? Do you think there's been any of that dynamic occurring?

Spencer (35m 26s):
For sure. I mean, there, there are many people who you you'll speak to who are in their more productive money, earning years, twenties, thirties, forties, fifties, sixties, who are pretty prudent and have amassed, nice nest egg. And you say, well, how did you get your start? Like, oh, I'm so embarrassed to tell you. The first thing that I did was somebody at work told me about the stock and then it went bankrupt and whatever. I think everybody on wall street, who's honest will tell you about some, you know, kind of naive a disaster, a disaster, right? So

Phil (35m 55s):
A tragedy, a tragedy comedy disaster of finance.

Spencer (35m 58s):
And, and I have stories like that myself that are horrible, right? So everyone, not everyone, but most people there's sort of the path to being on the straight and narrow financially started with a, a very nasty detour. So yes, I think that it is good with one caveat. I think it's good because some percentage of these people, now they have a financial account. It was not very cool for a young person to have any kind of a brokerage account. And now they do. And now they have some exposure to the stock market and they participated in this crazy thing. Maybe they even made money. I think it's worse if they made money, frankly, because the amount of money they made, you know, if you're 22 years old, the amount of money that you have to to save or to make is not very substantial in terms of the amount of money that you will.

Spencer (36m 39s):
I, I hope, you know, earn over your productive years. So if you lost money, that might be even better because you've, you know, you've been humbled. Success is a very bad teacher, but the way that this story ended has embitterd a lot of the people. And so I'm afraid that while some people, this will have planted the seed of a large fortune for them in the future for other people, it will have robbed them of a fortune because what happened a few days after I pinged the publisher and said, this would be a great book. And they got very excited and said, yes, yes, yes. Is that it took a very strange term because Robinhood and it's ilk did too good of a job, getting people excited because you had so many people using borrowed money to buy these stocks that the clearing house that makes sure that everyone gets paid and every broker is solvent and all the shares get delivered to the right place called up Robinson in the middle of the night and said, so many of your customers have bought this small number of stocks, many with borrowed money, many with money borrowed from, from you that in order to convince us that you are safe and secure in the next three hours, we'll need 3 billion from you, which was an impossible amount of money.

Spencer (37m 48s):
It's more than they had ever raised in their entire history as a company. And, you know, they were, you know, that was year six of their, their existence. And there was no way that they could do that. Even in 2021, where billions of dollars were just being thrown around at all kinds of dumb stuff. And the company was seeing more customers than it had ever seen. It signed up a million customers in a day during this whole period, there was no way. And so they went back to the clearinghouse. They said, well, we'll be about to be outta business. We can get $700 million on our bank credit lines. How about we call it 700 million? And then we don't allow our customers to buy anymore of these stocks. And they said, okay. And it was, you know, I, I can go into the details, but a whole huge conspiracy theory was cooked up that continues to this day that the hedge funds that were losing money intervened to stop them from trading, Congressional hearings were called, late night Comedians were joking about it on TV that night, it was a disaster would look like a disaster, at least for, for Robinhood.

Spencer (38m 48s):
And they were seen as like, they were like the sheriff of Nottingham, all of a sudden, they were like, you know, not stealing from the rich, but stealing from the poor. And it's a very mundane explanation for, for what happened. But it, the fact that people are so bitter about it makes them feel like wall street is a crooked place. It's mostly not a crooked place. It's not a place where you should go and go out and speculate. In my opinion, I think that speculation is usually a loser's game, but it's not a crooked place. You could make a lot of money on wall street. If you, you know, if you understand wall street and you only engage with it to the extent that you need to and only pay it, the amount that you need to. And so these people I'm afraid have been dissuaded from a, a lifetime of saving possibly because they see wall street as this place that as soon as you're doing well, the rules of the game were changed.

Spencer (39m 37s):
And so that's terrible, you know, and I'm, I'm afraid that that's has affected not some, not small number of people.

Phil (39m 44s):
It's incredible the way these memes and these ideas, and the thoughts just reverberate through so many, so many aspects of popular culture and finance, and one of the memes that I've seen lately. And I often see it's referred to on the socials is references to members of Congress profiting from bills before going before the house. Is there any truth to these?

Spencer (40m 7s):
I'm afraid that there is truth to it. And that is another thing that will SAP people's faith in, in markets up until, gosh, I think until 2015, it was wide open. So members of Congress, and there have been studies done up to that point. You know, you have to file some financial reports relatedly about what you own, what you bought. And some academics discovered that members of Congress were the best investors on earth. They were earning returns that would be the envy of headshot managers, well members of Congress, they might be smart. And some of them are not, not too bright, but it doesn't matter. It wasn't their smarts. They were earning them these huge returns. It was the fact that many of them, they knew what legislation was being worked on.

Spencer (40m 49s):
They knew what businesses could profit or could suffer, you know, as the pandemic was, was breaking. And as people weren't really sure in the United States, you had a woman who was a United States Senator from Georgia Kelly Loffler, whose husband was a, a very powerful guy on wall street who came out of a meeting, said, everything's fine, pandemic wise, and then went and, and dumped all over stocks. You had another politician who went and bought a whole bunch of shares in Gilead sciences, which had the one drug Remdesivir that thought at the time was able to treat the symptoms of, of COVID. So we had all kinds of, of people doing things like that, but you've had this repeated a thousand times and since 2015, it's been more difficult to engage in really what frankly is insider trading, but you've had one person ever prosecuted for insider trading.

Spencer (41m 36s):
And it was the kind of garden variety, insider trading, where the person was involved with the company. And it was a Congressman who went to, to prison and some relatives, his went to prison, the kind of insider trading that you or I would be prosecuted for. The little people get prosecuted for not members of Congress, members of Congress are, are somehow above the law. And you also had members of the federal reserve, not buying individual stocks, but trading repeatedly in index funds, which they're allowed to buy, which basically, but the, of course, we know that the stock market is, is impacted by decisions that the federal reserve takes. So I, it's not known whether or not they made extraordinary profits, but it, it really should not be allowed basically.

Spencer (42m 17s):
And there, there have been many attempts to, to do this. And I, I would be fully in support of just not allowing people and whether it's members of Congress members, people who have voting power on the federal reserve, or even high ranking bureaucrats to actively trade stocks or even index funds. There is no reason for them to do that. There are so many instruments available today where you could do it. And by the way, and of course, you know, you had our former president, president Trump who continued to, you know, to own, own his business. I mean, just to give you an example of what used to happen. And it was just purely a matter manner of tradition, not law, Jimmy Carter, when he was president, he had a peanut farm that was his main economic asset.

Spencer (43m 3s):
And he put his peanut farm into a blind trust so that he could not, I guess, influence the price of peanuts. So I don't know what he would've done, but he put the peanut farm into a blind trust. I guess whoever ran the peanut farm was not good at peanut farming because it kind of, you know, cost him a ton of money. He was very bad at running a peanut farm, but I mean, come on. I mean, it's, you, you know, you, you, you've taken this, this oath and you're, you're serving public office. You know, you're a member of Congress or the president or whatever. It, it just, it, it erodes public trust to be seen, making a lot of money or to have members of your family, making a lot of money. You have information that is very valuable. It's absolutely toxic to trust in the integrity of financial markets.

Phil (43m 45s):
Spencer, if you can tell us the name of the book again and where people can find out more information about it and more information about you.

Spencer (43m 53s):
The name of the book is the revolution that wasn't game stop Reddit and the fleecing of small investors it's available, wherever fine books are sold, or even where my books are sold. The spelling of my name is Spencer, J a K a B as in boy, a little unusual spelling of my surname. That's also my Twitter handle, Spencer, Jacob, if you wanna read my, my musings, most of my musings are about things that I'm editing or writing about at the wall street journal. But I hope people will check that out. The name of the column is heard on the street. We have people all over the world in Asia, Australia, and Europe, and the us 14 people write the column every day. I, I, I hope you check out the book and, and take an interest and thank you so much for, for having me to talk about

Stocks for Beginners is for information and educational purposes only. It isn’t financial advice, and you shouldn’t buy or sell any investments based on what you’ve heard here. Any opinion or commentary is the view of the speaker only not Stocks for Beginners. This podcast doesn’t replace professional advice regarding your personal financial needs, circumstances or current situation.