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OPINION | MAUREEN O’HARA: Bubble, boil and trouble

by MAUREEN O’HARA THE WASHINGTON POST | January 30, 2021 at 8:03 a.m.

The market gyrations involving GameStop’s 64-fold rise in price since August are certainly eye-opening. How a money-losing company whose stock previously traded less than 10 million shares a day can shoot up to trading 50 million-plus shares in a day—and cause the stock price of a completely unrelated but similarly named Australian company (GME Resources) to rise 50 percent on Thursday—is hard to reconcile with today’s uber-efficient high-frequency markets.

Short sellers in GameStop—mostly hedge funds that had been betting massively on the company’s stock to fall—had reportedly lost $23.6 billion as of Wednesday. They may find little consolation in the dictum often attributed to Keynes: “Markets can stay irrational longer than you can stay solvent.”

Then there is the explanation that says bubbles form when both irrational markets and irrational traders are at work. The notion that somehow markets are swept up in “manias” is still with us, but it has a long history.

The English mathematician Isaac Newton, in addition to his many well-known accomplishments, was a disappointed investor in the trading company that become known for the South Sea Bubble of 1720. Newton confessed, “I can calculate the motions of heavenly bodies, but not the madness of people.”

Scottish writer Charles Mackay must have been having similar thoughts in 1841 when he published “Extraordinary Popular Delusions and the Madness of Crowds.” Mackay took a dim view of the intelligence of individual traders and an even dimmer view of the collective intelligence of the market: “Men, it is well said, think in herds. It will be seen that they go mad in herds, while they only recover their sense slowly, and one by one.”

But history shows that individual asset prices can be swayed by collective trading driven by greed, fear or simply boredom. American economist Peter Garber, in “Famous First Bubbles,” concluded that the Dutch tulip bubble of 1636 “was no more than a meaningless winter drinking game, played by a plague-ridden population that made use of a vibrant tulip market.”

For those contemplating where the GameStop chaos ends, perhaps the best advice is to recall the German American economist Oskar Morgenstern’s dictum: “A thing is only worth what someone else will pay for it.”

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Maureen O’Hara is the Purcell Professor of Finance at Cornell University and a former president of the American Finance Association.


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