Speculation & The Underdog

Caption: “Museum Attendant (in 1925) These instruments, known as stock-tickers, were in use in Wall Street up to the year 1914. They were abandoned when the public got out of the market, and they are now very rare.”

Visualizing History

NYSE Short Interest Ratio: 1931 – 11/30/2020

(Source: Global Financial Data)

From the Archives

Inside Life in Wall Street (1873)

A favorite passage:

Investor Amnesia Course

Towards the end of last year I launched a brand new online financial history course covering Bubbles, Manias & Fraud. The course boasts more than six hours of content split into 37 videos across seven riveting topics like Railway Mania, the South Sea Bubble, Brewery Mania, and more. Students are taught this fascinating material by the world’s foremost investors and financial history experts.

Make sure to check it out!

Sunday Reads

Caption: “The counterfeiters of coin and the counterfeiters of securities” (Left: Low Down and Illegal / Right: High Up and Legal

There are some weeks where Friday rolls around and I realize there are no standout topics from the week or interesting headlines to provide context on through history. I think it goes without saying that this was not one of those weeks…

So, where the hell do we begin?

While we are obviously going to look at the many themes and narratives surrounding the events that transpired this week, I want to point out that the history of short squeezes, market corners, etc. was already covered in last week’s Sunday Reads (Power Grab: Activists, Shorts & The Masses). So if you want to read more on those topics specifically, definitely take time to read that post as well. To avoid covering the exact same aspects of the last two weeks I am going to spend today’s Sunday Reads touching upon the higher level themes and narratives coming to the fore as a result of what’s happened.

1. “Populist Finance” and the “Sticking it to Wall Street Suits” narrative
2. Robinhood’s Decision to Restrict Purchase Orders on Select Stocks
3. The Rise of Retail Investors

I think the illustration from 1908 shown below perfectly summarizes that first theme (except now the little man “has some show”):

A Two Tiered System in Financial Markets

Additionally, this description from a financial history article on the impact of Stock Ticker technology in democratizing finance offers an interesting view of how there has always been a literal or widely felt two-tiered system in financial markets: a tier for the wealthy elite and a tier for “the others”. This excerpt specifically describes the two tiered system that functioned on Wall Street in the 19th century:

“In the 1860s, just what did the words ‘Wall Street’ designate? Trade in securities was in fact carried out by two wholly distinct classes of brokers. One comprised members of the Regular Board, who inherited or paid hefty sums for their seats (they actually traded in tailcoats and tall hats, sitting on their personal chairs, from a fixed place in the room). The other class comprised brokers of the Open Board, who did not inherit any seats, paid much lower membership fees (less than one-tenth of what Regular Board members paid) and traded in the street (standing, of course). The public could not join the sessions of the Regular Board, but constantly mixed with the Open Board. The trading volume of the Open Board was estimated by some contemporaries to be 10 times that of the Regular Board.

The Regular Board traded by calls: securities were called out loudly, one by one. For each call, stockbrokers bought and sold according to orders received in advance; afterwards, trading was interrupted. The Vice President of the Board repeated the price to his assistant secretary, who repeated it to a clerk, who wrote it down on a blackboard. Then the next call was traded, its price was ceremoniously repeated, and so forth. The Open Board took the ground floor, the entrance to the building (the doors stayed open) and the street. The public was in and out all the time. The Open Board traded uninterruptedly and moved in the evening to the Fifth Avenue Hotel, so that its market was open for about 12 to 14 hours a day. By contrast, the Regular Board traded between about 10 am and 2 pm, and its members made sure they did not miss their lunch-breaks.

What do we have, then? We have a closed status group operating a discontinuous market (the Regular Board) and a relatively open group operating a continuous market (the Open Board).”

In short, while a major theme of the last few weeks has been the double standards and seemingly two-tiered system for what is permissible in financial markets between retail investors and legacy Wall Street institutions, this passage demonstrated that as far back as the 19th century there was quite literally a two tiered system on the NYSE.

There was a wealthy elite class that paid high fees for their exchange seats, and “traded in tailcoats and tall hats, sitting in their personal chairs, from a fixed place in the room”. Conversely, there was the second class of speculators and investors that were restricted in the streets. There were different procedures for trading in these two worlds despite operating out of the same location, and this system even engendered an environment where there were multiple prices for the same security between these two groups because of the different trading operations.

Trading in the street

Restricting Access to Speculative Trades

Following the decision of Robinhood to restrict trading in certain speculative stocks that have gained popularity as of late, many people have asked me whether there is a historical precedent for such a move. While there could certainly be an example out there, I was unable to find a direct parallel. However, I do think that the Bubble Act of 1720 has some similarities at a macro level. I’ve provided a free clip from my financial history course below in which Yale Professor and South Sea Bubble expert William Goetzmann details the Bubble Act and its implications:

“In 1720 there was a market for all sorts of new ventures, and some of these were crazy and some had possibilities. In 1720 the Bubble Act was enacted by Parliament which basically said any trades anybody does in these companies are null and void and they are not legal trades. This killed the whole venture capital aspect of the 1720 bubble.“

While it is not a perfect parallel to Robinhood’s decision, this was another example of trading suddenly being halted in the popular speculative stocks du jour. Additionally, in light of all the theories and conspiracies surrounding whether Robinhood’s decision was the result of a directive by Citadel and other hedge funds that were losing money on the short-side of these stocks, the Bubble Act yet again offers an interesting parallel:

“The most accurate reading of the Bubble Act is that it was passed at the behest of the South Sea Company’s (SSC) board of directors in order to draw investment away from the SSC’s competitors and maintain the momentum of SSC shares. This position was clearly articulated by John Sperling who found that “[t]here is good reason to believe that the Act resulted from the lobbying of the South Sea directors who wished to cut off speculation in these companies because it drew money out of the market in South Sea stock”. Support for this position is also found in Carswell, and more recently and stridently by Ron Harris (1994). The interpretive difficulty lies in the fact that the BA did herald the collapse of the South Sea Bubble, despite having been passed with the opposite intent.”

Now let’s dive into the historical context behind these crazy few weeks!

Yahoo! Finance TV Appearance

Scenes from a Power Struggle: The Rise of Retail Investors in the US Stock Market

One of the primary narratives surrounding this episode of retail speculation in recent weeks is the Retail Investor vs. Wall Street Institutions (“The Man”). This paper looks at the history of this conflict / power struggle within the US stock market.

Summary:

“This chapter examines the mass movement of Americans into investing during the 1990s as both a consequence and a cause of contested power between corporations and individuals. This movement was part of a larger historical pattern of economically marginalized people consolidating their power through associational strategies in the realm of finance. Using US investment clubs as a case study, the chapter draws on Foucault’s theories to illuminate the bilateral power structure of modern capitalism, in which market institutions and small groups at the grassroots level mutually influence one another. While the investment club movement was in part a response to economic domination by corporate and political elites, it also catalyzed genuine shifts in the power dynamics between individuals and corporations.”

Notable Quote:

“Indeed, every amateur investor movement in history has been interpreted this way: as a subversive appropriation of the technologies of dominance (Foucault, 1988). The seriousness of the threat can be gauged by the degree of retribution unleashed on the subversives. In this regard, the US amateur investment boom of the 1990s followed the same pattern as the earliest known financial manias, such as the British South Sea Bubble of 1720. In 18th century Britain, as in 20th century America, he impetus for popular involvement in investing came from elites themselves: while American corporate leaders were trying to maximize profits by unloading risks and responsibilities onto employees, the British elite of two centuries earlier were seeking to pay off the country’s crippling war debts by raising money from the public. Instead of taking the unpopular step of raising taxes to pay that debt, Parliament authorized a public stock offering, purporting to sell shares in a government-backed trading enterprise known as the South Sea Company. The same elites who floated the idea of nationalizing the war debt later profited handsomely from insider information on this undertaking, selling their shares before the whole public offering collapsed in disgrace a year later – bankrupting many of the less privileged investors.”

A Shackled Revolution? The Bubble Act and Financial Regulation in 18th Century England

Jason Zweig wrote an incredible article detailing this engraving

Why This is Relevant:

The decision by Robinhood and other leading brokerage firms to restrict investor’s ability to execute purchase orders on certain speculative stocks like GameStop caused an outcry to the extent that even sworn enemies like Ted Cruz and Alexandria Ocasio-Cortez found themselves agreeing with each other.

“Revisionist estimates of growth rates during the British industrial revolution, though largely successful in presenting a more modest picture of Britain’s ‘take-off’ prior to the 1830s, have also posed fresh analytical difficulties for champions of the new economic history. If 18th-century Britain was witness to a diffuse explosion of ‘useful knowledge,’ why did aggregate growth rates or industrial output growth rates not more closely shadow the pace of technological change? In effort to explain this paradox, Peter Temin and Hans-Joachim Voth have claimed that a few key institutional restrictions on financial markets – namely the Bubble Act, and tightening of usury laws in 1714 – served to amplify the crowding out impact of government borrowing. Against this vision, the present paper contends that the adverse impact of financial regulation and state borrowing in 18th century Britain has been greatly overstated. To this end, the paper first briefly outlines the historical context in which the Bubble Act emerged, before turning to survey the existing diversity of perspectives on the Act’s lasting impact.

It is then argued that there is little evidence to support the view that the Bubble Act significantly restricted firms’ access to capital. Following this, it is suggested that the “crowding out” model, theoretical shortcomings aside, is largely inapplicable to 18th century Britain. The savings-constrained vision of British capital markets significantly downplays the extent to which the Bank of England, though founded as an institution to manage the public debt, provided the entire financial system with liquidity in the 18th century.”

“That the Bubble Act was passed at the behest of the South Sea Company does not, of course, automatically imply that it had no lasting effects on the process of industrialization. Though unchartered corporate partnerships developed throughout the hundred-odd year period that the Act remained law, partners in these companies did not enjoy limited liability, possibly limiting the number of investors that could be attracted to industrial ventures. Indeed, Temin and Voth are not alone in elements of this supposition, despite being more forceful in their conclusions. Alfred Marshall10 (1919), and Armand DuBois (1938) long ago suggested that the more widespread adoption of the joint-stock form was markedly constrained by the Act. 

The Piggly Crisis

Even though we extensively covered the history of short squeezes and market corners last week, the Piggly Crisis has proven to be a particularly popular example for investors this week so I thought it was worth sharing this excellent account of what happened from the team at Global Financial Data.

Visualizing History:

“Clarence Saunders also became part of the last stock corner on the New York Stock Exchange in 1923. The corner became so prominent, that the whole affair became known as the Piggly Crisis. Clarence Saunders was generous, determined, stubborn, and well-known in Memphis. Saunders became known as the home boy who faced off the financiers of Wall Street who were using a bear raid to try and profit from a decline in Piggly Wiggly stock.

Piggly Wiggly shares started trading over-the-counter in July 1920 and listed on the New York Stock Exchange (NYSE) in June 1922. In November, 1922, several of the independently-owned Piggly Wiggly stores in New York, New Jersey and Connecticut failed and went into receivership. Although Saunders’ corporation operated independently of these stores and was profitable, some Wall Street operators saw this as a reason to begin a bear raid on Piggly Wiggly stock. The bear raiders began selling Piggly Wiggly short and spread rumors that the company was in poor shape. Saunders took this challenge personally. He had created Piggly Wiggly stores, created the concept of self-shopping, was spreading his stores across the country, and some bears were trying to create profits by spreading lies about his stores. Saunders decided to “beat the Wall Street professionals at their own game.” Saunders not only used his own money to battle the shorts, but he borrowed ten million dollars from a group of bankers in Memphis, Nashville, New Orleans, Chattanooga and St. Louis to buy up the existing float.

In the Wall Street of the 1920s, bear raids came and went. Companies didn’t go bankrupt because of bear raids, and if the fundamentals of the company were sound, the stock would bounce back after the bear raid was over. Nevertheless, Saunders refused to give in to the Wall Street city slickers. Saunders hired Jesse L. Livermore, the most famous bear on Wall Street, to help him break the back of the bear raiders. Within a week, Livermore had bought 105,000 shares of Piggly Wiggly, over half the float of 200,000 shares. The bears had shorted Piggly Wiggly stock in the 40 range, but by January, Saunders’ bull campaign had pushed the price of shares past 60. The shorts were losing money.”

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