 Welcome back everybody. I'm Peter Clausi. This is Investor Intel. Like many people, I was confused by the GameStop phenomenon. So when you're confused, you reach out to experts to help you. And today we have Dr. Richard Smith, an expert in this field, to help us figure out what's going on. Welcome, sir. It's great to be here, Peter. Thanks for having me. Now, before I ask the big question, can you give us a 30-second rundown on your bio so we know why you know what you're talking about? Sure. So I developed some mathematical tools to help people calculate with uncertainty better in grad school. Then I got interested in the stock market, developed some financial technology for 20 years, sold my company last year, and then became the chairman and CEO of the Foundation for the Study of Cycles. We're a 501c3 not-for-profit and still involved in the economy and markets, but also just interested in cyclical phenomena more broadly. So this is exactly in your wheelhouse? Absolutely. And really, I've been a passionate advocate for retail investing and participation in the markets, not just by institutions and professionals, but by independent investors. So let's assume that everybody who's watching this actually has some idea of what's going on with the GameStop story. As of today as we're filming, it's around $315, according to my math right here. It's been as low as 20. It's been over 400. What drove it up and what's keeping it up? So this has been what's called a short squeeze. So there were a lot of institutional hedge funds that decided GameStop was the next block buster and it was going to be going out of business any day now. And so they bet that the price was going to fall. So they sold what they didn't have? They sold what they didn't have. They borrowed shares from somebody else and said, hey, I'm going to borrow your shares. And then they hoped that they would be able to buy them back at a much lower price and then return them to the person that they bought them from when they were much less valuable. And you make money that way. And this is nothing new. This is a common technique used all the time. Absolutely. And really, but what's happened here is that this kind of crowd sourcing a short squeeze has had a couple of unique drivers to it. One is that a lot of the people on Wall Street bets actually love GameStop. They think they don't want it to go out of business. They thought it was actually a compelling investment opportunity. Really, I think many of them genuinely do or did. And then you have a lot of disenfranchised populism going on in the world right now. To me, what's happening here on Wall Street bets is not completely unfamiliar in terms of what happened at the storming of the capital on January 6th. I think they're related currents. And then plus you have the entertainment factor and the greed factor that this thing has started working and the crowd is piling in. And I'm sure that the institutions are making plenty of money on this too. And they're in the game. There's a few that got caught with their pants down, I guess, but... Melvin capital. Melvin capital and a few others. But I'm sure plenty of them are like, woo-hoo, let's go, volatility. This is our game. I'm not crying in my beer over the institutions and Wall Street. And really, I guess the other phenomenon is Robinhood. And what people don't understand is that Robinhood, much like Twitter, Facebook, Google, they just make money off of engagement and growth and transactions. They have no skin in the game when it comes to the outcome for their clients. They make money off of lots of users. And they actually get paid by the market makers, like Citadel Securities, Susquehanna, et cetera. Robinhood gets paid for delivering customers trades to the market makers. That's called payment for order flow. And you'll hear this has been going on forever. Brokers have always made money on payment for order flow, but nowhere near the level of what Robinhood does. They're a privately held company, so we don't really know what their gross revenues are. But in the third, second quarter of 2020, they did $200 million of business with market makers. And what do they normally get paid for that? Who? Robinhood or market makers? Robinhood. Well, I mean, they got paid $200 million in the second quarter of 2020 by the market makers. This is actually new information that is available because the SEC forced a rule change to require market makers and retail brokers to disclose these payment for order flow revenues. So what I'm saying is that Robinhood makes a lot of money when there's a feeding frenzy, and so do the market makers. And so I think that this is structurally kind of built into the way that markets are starting to work more and more, just the way in the same way that, say, the election fraud and the storming of the capital are sort of built into the structure of Twitter and Facebook and Google, where you're just getting paid based on engagement and growth and as many clicks and hits on your platform as possible, irregardless of the value of what's being communicated on your platform. So the content matters less than the medium? Which goes back to our mutual admiration for Marshall McLuhan. I think people should read Marshall McLuhan today to see how prophetic he was. I don't actually. I'm still getting up to speed on Marshall McLuhan myself. You know, I've really come to see the world largely in terms of this kind of media synthesis technology. I mean, media technology synthesis. And a lot of what's taking place is actual propaganda techniques that are arbitraging behavioral biases of the public and the risk illiteracy of the public. So my background is in quantifying risk and uncertainty. And I'm a big advocate of risk literacy for the public. And a lot of the technology that I've built have been tools that bring risk management tools to the public that professionals typically use, but amateurs don't. And I think that, you know, that's what I learned in the stock market after 20 years was that your it's human behavior that's really being arbitraged in the markets by the professionals on the amateurs for the most part. So this is being portrayed in some circles as Main Street USA against those bastard billionaires down on Wall Street. But from what you're saying, that play is not accurate. Well, I think there's some truth in it, just like there's truth in, you know, that there were grievances among the people who stormed the capital, right? I just I agree with the motivations. I don't agree with the methodologies. And I don't agree that this this group of people on Wall Street bets represents the mainstream public, right? There are a few hundred million people in the United States, probably 100 million of them capable of investing, have some capital. And the vast majority of them are not looking to, you know, jump into a stock that's up 1000% in the hopes that it's going to go up 2000%. And there's, you know, 10,000 stocks in the publicly traded markets in the United States give or take. And, you know, we're talking about maybe 10 stocks that have been the focus this week. So let me pause it a theory at you. Sure. Every system has data outliers. Every system has aberrations and mutations. Is this GameStop phenomenon the new normal, or just an outlier within the existing system? I think it's an outlier within the existing system. Again, I don't think that in many ways this isn't anything new. And it's disconcerting to me personally as somebody who actually believes in capital formation and capital allocation as a meaningful, you know, driver of our culture and our society and our economy that this dynamic in markets is as prominent as it is. You know, there's so much mechanization that's going on, so much computerization. It's so much driven by algorithms and high frequency trading and arbitrage of the market makers. And I don't believe that it really has a whole lot to do with genuine capital formation. So I think this is an outlier, you know, I think it'll be figured out by the institutions, you know, sooner rather than later. And they're probably profiting on it in the meantime as well. There are stock exchanges around the world that have speed bumps to prevent the algos from doing inter-exchange trading. Yes. That have helped here? I think so. And I think that I hope those new experiments in stock exchanges are starting to get some more attention from this episode. So my hope is that this episode will ultimately lead to scrutiny and introspection. That's a... Scrutiny of whom? Well, scrutiny of the system, I would say, and scrutiny of market architecture. Big picture thinking. Big picture thinking. Yes, scrutiny of technology. You know, I think this is related to the regulatory questions that are going on around, you know, technology right now. You've got Google and Facebook and Apple and Amazon and others being scrutinized of, you know, is this really good for consumers to have this much power and influence? And what's really going on is free, really good for consumers, right? Because what's really happening here is this is a user as product business model, okay? Robin Hood's users are not its account holders. I mean, Robin Hood's customers are not its account holders, right? Robin Hood's customers are primarily Citadel securities and other market makers. So their users are their product, not their customer. Much as a Facebook user is not really the customer. Exactly. Google doesn't really care who you are as long as they can identify you. Exactly. So, you know, you have all this antitrust legislation history that's largely based kind of on this idea of like price fixing, but, you know, how do you apply that to free, right? How can you say free is bad for consumers? Unless you can somehow put a value on your identity. I think it is. And I think that is actually a change that is that people are catching on to. And I think that more and more people are concerned about the way that privacy has, you know, really been neglected for the past 20 years. And I hope that rather than have a kind of reactionary regulatory action that it'll lead to some reflection about, you know, how markets should really work, at least as far as retail investors are concerned. So in the EU, two years ago, they passed the GDPR, General Data Protection Regulations. Yeah. And the consumer has seven rights. And the most fascinating one for me is the right to be forgotten. You can call Starbucks to delete any reference to you anywhere in their records. Yeah. That's a fascinating power. I completely agree. And I really hope that we'll see something in that direction in the United States. Another thing they do over in the EU, they have the European securities and market authority, I think, and they force some of their brokers, especially the ones that are involved in more speculative areas like Forex, to post on their website. First thing you see, X percent of our customers lose money. Really? And the minimum is 75 percent. I've seen, you know, brokers where it says, you know, 100 percent of our customers lose money. And they're still opening up accounts, you know? So in many ways, the public only has itself to blame. Every individual thinks you're smarter than everybody else. That does seem to be the case. The wisdom of the crowd. Okay, I know you've got a hard stop. It's been fascinating talking with you. As the story develops and plays out and mutates, go check back in and see what you're thinking. Absolutely. And look, I don't think this is a one-sided story. I think it's interesting. I don't think it's quite as worthy of all the attention that it's getting. And again, the first principle of successful investing that I just got, I interviewed Jack Schwagger. He did the Market Wizards books, right? And he said 90 percent of risk management is about knowing when you're going to get out before you get in. Hmm. Okay. And I don't think most of the people getting into GameStop today know when, where they're going to get out and how much they're willing to risk, you know, for the opportunity. It's falling 40 bucks a share since you and I started chatting. Yeah. And the biggest behavioral bias that everybody has in the markets is two Nobel prizes in economics have been awarded for this. It's loss aversion. We hate to lose. But when we're losing, the fact that we hate to lose makes us not want to sell. We want to hold on because selling equals loss, right? But when we're winning, the fact that we hate to lose attaches itself to our profits and we want to sell. So we're risk seeking when we're losing and we're risk averse when we're winning. And ultimately that tips the scales towards your losses. And that's why it's so important that you know where you want to get out. It's an old evolutionary mutation for human beings. Yes. Not exactly a survival instinct. Anyways, Dr. Smith, I thank you so much for your time and wisdom. Thank you. It's been a pleasure to speak with you and I'd be happy to speak again. Peter Clossey for Investor Intel. Have a safe day.