Our stock market is completely broken. Now what?

In school, I was always taught that stocks are supposed to represent ownership. If I own stock in a company, I share in that company’s dividends, and get voting rights in that company’s future. Stocks are supposed to represent a profit-sharing agreement between stockholders and the corporation. It used to be that way.

However, today, many companies on the S&P 500 don’t even pay dividends, including big ones like Amazon and Google.

Google shares grant no voting rights to investors, and no obligation for dividends. It’s why Google can earn $30 billion over a four-year period and yet see its stock price remain stagnant. Amazon won’t give its shareholders a proposed schedule of liquidation; if you truly owned a piece of the company you’d be entitled to ask for it. Yet possessing stock in these non-dividend-paying companies is not the same as having ownership of the company. Their stock is just a piece of paper that you can sell to other investors, which is treated as a separate entity from the company itself. It’s more akin to a legal Ponzi scheme.

I’m not talking about literal Ponzi schemes, although those are still extremely common right now. Bernie Madoff would be proud: Kathy Bazoian Phelps, the lawyer behind The Ponzi Scheme Blog, has identified three to 10 new Ponzi schemes every single month since the 2008-2009 Madoff scandal. But I’m talking about the entire stock market itself, where the success of an investment depends on the investors who come in later, and at a higher price. The more investors who buy stock, the more the price goes up, making that stock seem like a good investment to others. More people buy, which pushes the price far beyond the actual value of the company. There comes a breaking point where the only hope to make money lies in the belief that people coming after you will push the stock even higher, valuation be damned.

That is exactly how a Ponzi scheme works.

I am not the first to make this comparison, of course. A book entitled The Ponzi Factor, by Tan Liu, points to many examples that show the discrepancy between a company’s value and their stock prices. Tesla stock was trading at $20 in 2010, and by 2017 it had risen to $380. However, that same year, Tesla reported a staggering loss of $4.3 billion. As of this writing, Tesla’s stock is hovering around $700; 2020 was the first time the company reported a full-year profit.

An even better example just happened in February, which led me to write this. I’ll give you the rundown, because it’s quite a story. Robinhood, of course, is a brokerage app that allows anyone to make “free” trades on the market. Trades are only free because Robinhood makes a large percentage of its profits by routing users’ trades through companies known as market makers. They make the rest of their money in other ways, such as from the interest in users’ accounts.

Remember: If you aren’t paying for a product, you are the product.

Members of r/wallstreetbets—a Reddit community of mostly amateur investors, though not all—noticed that some large Wall Street hedge funds were betting against GameStop, a brick-and-mortar video game store fading fast in an age of downloaded games and online shopping. Hedge fund managers assumed the outdated company would go the way of Blockbuster, and devised a quick way to make a lot of money by betting against its stock. This practice is called shorting. This goes against the entire point of having a stock market, but I digress.

Essentially, shorting a stock means borrowing shares of stock from a broker and immediately selling them, just before a stock is expected to drop. Instead of hoping their stock goes up, as a shareholder does, short sellers only make money if the stocks go down. Once it drops, the hedge fund managers buy the borrowed shares back at a discount and return them to the broker, making a profit.

If you get this concept, you can skip my explanation in the box below. But if your eyes glazed over, let me give you an easy example. 

Shorting a Stock:

Suppose you have four collector’s stamps worth a buck each. I ask if I can borrow them for a week, and you let me because  you’re cool like that. I immediately sell those four stamps to a dealer/sucker for four dollars. (Four stamps at $1=$4.)

Then, one week later, I have to give you the stamps back. But BAM! Their value drops!  Now the stamps are only worth 25 cents each! I buy them all back from the dealer for a buck. (Four stamps at .25 =$1.)

So I sold the stamps for four bucks, and bought them back for one buck. That means I made $3 profit off of your stamps. Even if you charged me a little bit of interest for borrowing them, I still made a pretty sweet deal.

Now do this with real money, millions of times over, and you get an idea of why hedge fund managers are so rich.

And if that didn’t do it for you, Twitter has an even easier explanation.

Hedge fund managers are allowed to buy millions of shares at one time, and they do. The problem in the GameStop fiasco is that the hedge funds got waaaay too greedy. The price for the stock at GameStop dropped significantly, as expected, but the hedge funds waited and waited, hoping to ride it out until the stock dropped to near zero. Though they had borrowed money to borrow the shares, it appeared they were waiting for GameStop to go bankrupt—a best-case scenario, where they wouldn’t even have to bother to buy the shares back.

The Reddit group caught on to what the hedge fund managers were doing, and they turned the tables by betting against the hedge funds. Soon, thousands of the so-called “retail investors” were buying thousands of shares of GameStop on Robinhood and apps like it.

In late January, GameStop stock was suddenly worth more than either Apple or Walmart. This made absolutely no sense at all, but it was hilarious to see Wall Street scrambling. Some called it the “Reddit Rebellion,” and the media ran story after story about the little people revolting and beating Wall Street at their own game. Crowdfunding billboards began popping up in cities urging people to buy (and more importantly, hold) $GME so they could get in on it. One Twitter user paid $18 for one hour to rent billboard space in Times Square. It worked, and millions of investors did just that.

For a brief period of time, it looked like the little guy was, for once, going to have a Trading Places moment.

But in real life, Wall Street always wins. Consider the tale of two Citadels.

​Robinhood generates a huge amount of revenue from Ken Griffin’s Citadel Securities. Citadel makes users’ trades for the Robinhood app, so it briefly knows what investors are buying and selling before the trade is made. It’s legal, even though it’s a conflict of interest.

Even as Citadel Securities was making the app’s rapid fire $GME trades, Citadel LLC, Griffin’s hedge fund, was bailing out Melvin Capital—a hedge fund that was near-fatally exposed by the GameStop fiasco.

Robinhood then took the unprecedented step of blocking their customers’ trades on stocks targeted by r/WallStreetBets, including GameStop. App users could sell $GME, which would drive the price down, but could no longer buy it. The backlash was immediate, drawing bipartisan condemnation from Congress. The House Financial Services Committee announced a hearing on hedge fund manipulation.

Several Robinhood customers claimed Robinhood went beyond freezing their ability to buy. Robinhood vehemently denied this; users shared screenshots allegedly showing that Robinhood sold off their shares without their consent.

The billionaire Robinhood CEO, Vlad Tenev swears that saving all things Citadel wasn’t the reason for the shenanigans, citing market dynamics and clearinghouse deposit requirements.

Those sudden concerns just happened to favor the hedge funds.

Such Wall Street games are legal because Ronald Reagan successfully pushed for massive deregulation of the stock market in the early 1980s. Bill Clinton made it even worse when he signed legislation in 2000 that further deregulated the market. At least Clinton admits that he later came to regret it, especially after the 2008 stock and housing market crashes.

There are many flaws in American financial markets, but the practice of using stock options for executive compensation is one of the worst. Quite simply, the practice encourages those at the top of a corporation to loot their company for short-term gains. Since stock options are now the dominant form of senior management compensation, executives are now incentivized to only focus on immediate results, at the significant expense of the long-term goals of the operation. Forget about any consideration for the general welfare of the public or the environment.

Worse is the manipulative practice of stock “buybacks.” It used to be that when companies had a large surplus of cash, they would invest in the company, hire more workers, roll out a new product, or conduct research and development. After Reagan deregulated the stock market in 1982, companies had a new option: buy their stock back. Stock buybacks were illegal up until then because it is blatant market manipulation. Long story short, if the company buys back a lot of its stock from the marketplace, then earnings are distributed among fewer shares, which then raises share value. Corporate executives have quite an incentive for doing this because their compensation is now tied to the stock market. Many executives do it, including GameStop’s new CEO back in 2019.

As recently as 2018, when corporations received that gigantic corporate tax break from Trump’s GOP, American companies used that money not to raise wages or innovate, but to buy over a trillion dollars in stock buybacks. This money didn’t go toward company investments, but it sure did make the wealthy class even richer. Since the Reagan era, income inequality has soared in large part due to the explosion of such compensation packages tied to the stock market for corporate executives, who today make up almost 60% of the top 0.1% of earners. This destructive behavior destroys the middle class, stifles innovation, and depresses wages.

Yet the real problem with the stock market, at least according to NASDAQ CEO Adena Friedman, isn’t the games that Wall Street likes to play, or the buybacks, or the decades of deregulation. No, the problem is poor people, like you, like the so called “retail investors” of r/WallStreetBets, who had the gall to talk to each other on social media about investing.

The solution, Friedman says, is to stop social media coordination; she even bragged about having new technology to monitor social media during trade activity so they can “Robinhood” them by blocking their ability to buy shares.

Take that, poors.

Now, I am not an investment adviser, and I am certainly not suggesting that anyone reading this shouldn’t invest in the stock market, especially if your company matches your 401(k). Stocks are definitely the easiest way to invest, and that’s by design.

Yet for we poors, there are opportunities outside the stock market that are worth considering.

Bonds:

Unlike stocks, which are sold on a centralized market, bonds aren’t publicly traded on any exchange. Instead, you must buy them from brokers. You can also buy U.S. Treasury bonds directly from the government. The bond market is regulated by the Financial Industry Regulatory Authority (FINRA). Unlike stocks, you must get paid regardless of performance. It’s like a loan. Our country would be much better off if we had a large-scale, regulated bond market instead of the stock market we have today.

Real Estate:

Real estate is always an alternative. It’s not as easy as buying stock, requires a lot of research, and definitely has more initial investment. But real estate offers more stability and lower risk than stocks, plus better returns and greater diversification.

However, if you can’t afford or don’t want to own property, real estate investment trusts (REITs) are a different way to invest in real estate, with a lower entry point. They are bought and sold like stocks, and by law, 90% of the profits must be distributed as dividends to shareholders.

Agriculture:

I’m not talking about running your own farm, although that would be pretty awesome—and the government does allow a 100% tax deduction for the costs of running a farm. (Just sayin’.) If you don’t want to buy a farm, Farmland REITs purchase farmland in a wide geographic area and then lease the land to farmers; investors earn a return on owning farmland without owning one. Additionally, several platforms provide access to farmland investments through crowdfunding.

If you think about it, no matter the state of the economy, people have to eat; now there are ways to own a slice of sustainable farmland for a heck of a lot less than the cost of buying an entire farm.

Stock reform is desperately needed, and it’s one of those rare issues where there’s enough bipartisanship to get something done, but honestly, I don’t expect any significant change to happen in my lifetime. The economy will have to crash many more times before people seriously discuss a complete overhaul of the stock market.

Biden’s pick for the SEC is Gary Gensler, who proved to be a strict regulator of big banks when he headed the Commodity Futures Trading Commission. He didn’t mention Robinhood by name, but said one of his top priorities will be to conduct a thorough review of the issues regarding trading apps. Robinhood’s leadership, as well as that of Citadel, Melvin, and yes, even r/wallstreetbets, found themselves in the House hot seat in February.

Look forward to more congressional hearings and regulatory probes in the near future, as well as dozens of lawsuits from angry users. (Good luck on that IPO launch this month, guys.)

It’s a good start, but we need to do more than just focus on a few bad actors. Congress should, at minimum, create an independent commission, with subpoena power, to fully study the dishonest structure of the current U.S. stock market. Only then can we unite to find real solutions for reform. Americans deserve at least that much.