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Illustration: Aïda Amer/Axios

The stock market has failed at its most important function.

Why it matters: It is supposed to be able to put a reliable price on companies, and efficiently allocate capital to the places where it can do the most good. That certainly hasn't been the case with GameStop, AMC, and other meme stocks.

Driving the news: Treasury Secretary Janet Yellen convened key financial regulators Thursday to talk about what, if anything, might be done to prevent a spectacle like GameStop from happening again. Later in the month, both the House and Senate will hold their own hearings on the subject.

  • So, what is the government going to do about it?
  • Three possible answers are being put forward by legislators and lobbyists: A crackdown on market manipulation, a financial transactions tax, and the abolition of payment for order flow.
Market manipulation

Artificially manipulated markets cause investors to lose faith in the stock market as a whole, and result in capital being allocated inefficiently. We’ve seen a lot of market manipulation over the past couple of weeks, a lot of it initiated by Reddit’s WallStreetBets forum.

  • John Chachas of Methuselah Advisors characterized the activity to the WSJ as "the worst kind of market manipulation,” but there's no reason to believe that it's illegal.
  • What they're saying: "Investors, big and small, are treating the stock market like a casino," wrote Sen. Elizabeth Warren in a letter to the SEC. "The recent chaos reveals a clear distortion in securities markets," she said, adding that "SEC’s standards and enforcement of market manipulation remain woefully unclear."

What's next: Under Trump, the SEC took a largely laissez-faire approach to markets. Under Biden, market manipulation could become clearly defined — and outlawed.

Financial transactions tax

The action in GameStop proves that liquid, high-volume markets aren't necessarily efficient markets. In fact, the opposite can be the case — which means that proponents of a financial transactions tax are seizing on the GameStop saga.

How it works: A tax of maybe 0.1% would be applied to all stock-market transactions. That would discourage ultra-high-frequency trading, and also act as a way of taxing stock-market speculation.

  • What they're saying: "Such a tax would have the beneficial effects of curbing instability introduced by speculation," wrote Larry Summers in a famous paper evaluating the costs (low) and the benefits (high).
  • Where it stands: Jurisdictions including the UK, Hong Kong, Switzerland, and Singapore all have vibrant capital markets and also a financial transactions tax.
Abolishing payment for order flow

A central part of the GameStop story was the army of Reddit day-traders enabled by zero-commission sites that are effectively funded by high-frequency trading shops.

  • When there isn't a trading commission to give you pause before putting on a trade, people tend to trade more frequently. App-based trading can feel like an investing game where people experience exciting wins and losses on a daily basis.

Context: Apps like Robinhood can only operate commission-free because they get nearly all of their revenue from another source — payment for order flow.

  • Where it stands: PFOF is illegal in places like the UK and Canada. A simple SEC rule change could make it illegal in the U.S., too.

Go deeper

Felix Salmon, author of Capital
Feb 4, 2021 - Economy & Business

Why people love to hate Robinhood

Illustration: Aïda Amer/Axios

Never has a company been so popular, and also so hated.

Why it matters: We're now at a key inflection point in the Robinhood saga that's likely to determine whether having a snazzy app with name recognition is all you really need to overcome internal weaknesses.

Feb 3, 2021 - Podcasts

Hedge fund billionaire Ray Dalio on the Reddit revolt

The GameStop stock saga was mostly viewed through the lens of small retail investors finally putting one over on big hedge fund manager.

Axios Re:Cap speaks with Ray Dalio, founder of hedge fund giant Bridgewater Associates, to get his perspective on the past week and whether it reflects a fundamental rot in the stock market and U.S. economy.

Local Florida leaders eye ways to take on DeSantis' anti-mask stance

Photo: Joe Raedle/Getty Images

With Florida at the forefront of the nation's COVID surge, local governments across Tampa Bay are wondering if — or how — they can subvert Gov. Ron DeSantis' administration to do something to slow the spread.

Why it matters: A day after Florida broke its record for daily cases, it did the same for the total number of COVID hospitalizations — set way back in July 2020, per the AP.