Conspiracy or kludge?

The unfortunately named Anthony Denier says,

in reality, what’s going on is that there is a two-day settlement between if you buy the stock today, those brokerage firms that you bought that stock on have to fund that trade with the clearing central house called DTC for two whole days. And because of the volatility of stocks, DTC has made the cost of the collateral of the two-day holding period extremely expensive.

…So the brokerages or the clearing firms have to go into their own pockets to do it. And they simply can’t afford the cost of that trade clearance. That is the reason why these stocks are coming off. It has nothing to do with the decision or some sort of closed room cigar– smoke-filled cigar room of Wall Street firms getting together to the dismay of the retail trader. This has to do with settlement mechanics of the market.

Pointer from Tyler Cowen.

This reminds me that back in the housing market collapse a lot of the foreclosure paperwork was flawed. This was not some conspiracy on the part of lenders to improperly foreclose on homes. It had to do with the mismatch between the mortgage securities market, where the lender of record could in some sense change in seconds, and the antiquated housing title system, where records are stored at a county courthouse, often in paper format, with a cumbersome process for updating that could take. . .almost forever.

I would bet that the two-day settlement delay in stocks is as anachronistic as the real estate title system. When you have a system that wants to be instantaneous but incorporates a process that hasn’t been updated in decades (or longer), this is what you get.

Once again, I am violating one of my norms, which is not to pile into the latest news. But here goes:

1. This seems like partly a Charles Kindleberger moment. In Manias, Panics, and Crashes, he adapts the Minsky model to major historical financial manias. Kindleberger’s thesis is that when there is a major shock that shifts a lot of wealth to a particular population, manias can ensue. The tulip mania is the classic example.

Over the past twenty years, we have seen a massive shift of wealth toward the tech sector and finance. Then the virus hit, accelerating these trends. Then the government printed enormous amounts of paper wealth as “stimulus.” All of this was enough to fuel asset bubbles.

2. This also seems like partly a Martin Gurri moment. Individual investors were participating in the financial equivalent of the Capitol riot. Some of them do not care whether or not they make a profit–they are in it for the schadenfreude.

In fact, I think this is an even more severe blow to American prestige than the Capitol riot. The U.S. can station enough troops in DC to convince the world that Congress cannot be invaded so easily. But there is no straightforward that I can see to reassure investors of the integrity of the market.

Right now, large investors are scared of what small investors can do, and conversely. How do you ease the fear on one side without increasing the fear on the other side? How much does the market rally of recent years depend on small investors, and what sort of reversal could we see if those investors bail out because they believe that the system is rigged against them?