Young investors trading meme stocks based on social media haven’t caused a financial meltdown yet, but the Federal Reserve said it’s keeping an eye on them.
- Social media and meme-stock trading can affect market sentiment dramatically, the Fed warned in a new report.
- The Fed acknowledged broader market implications of meme-stock volatility have so far been limited, but reiterated they needed monitoring.
- Meme stocks such as GameStop saw extreme share price volatility when individual investors banded together to create losses for hedge funds betting against those stocks.
- The Fed is not the only regulator considering mechanisms to reinforce market stability structures.
Social media helps create an “echo chamber” where like-minded retail investors share their views and interests, “thereby reinforcing their views, even if these views are speculative or biased,” the Fed said in its Financial Stability Report released this week.
“More generally, social media platforms allow a single comment or post to reach millions of people and potentially affect market sentiment dramatically within a short period,” the Fed said.
In January, individual traders on Reddit decided to gang up on hedge funds to buy shares in GameStop, a stock that major hedge funds had bet against. The call to action was for the traders to buy GameStop shares to propel the share price higher and impose losses on hedge funds that held short positions in the stock.
The frenzied trading in GameStop shares and its eventual sharp decline even captured regulators’ attention. But that volatility created ripples in the broader financial system. Brokers such as Robinhood were forced to restrict trading in GameStop shares to meet clearinghouse deposit requirements. Rules require brokers to deposit some money with clearinghouses to cover risks until a trade settles. Meanwhile, Melvin Capital, a hedge fund that had held short bets against GameStop for years, had to close its positions at a significant loss and required a $2.75 billion capital infusion.
So far, the broad implications of bursts of retail-led trading and related meme-stock volatility have been “limited” and have come and gone quickly, the Fed acknowledged. However, they still “should be monitored” and eventually “may require further steps to ensure the resilience of the financial system,” the Fed said.
What worries the regulator is that social media interactions may fuel high risk appetites and episodes such as those that occurred in January 2021 may be difficult to predict.
And the Fed is not the only regulator contemplating action. In the aftermath of extreme volatility in GameStop and other meme stocks, the Securities and Exchange Commission has also been considering steps to strengthen the market’s structures.
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