Fed: Meme Stocks Might Blow Up U.S. Economy One Day

The Federal Reserve warned Monday that a growing appetite for risk and the rising popularity of so-called meme stocks could pose a risk to the economy’s stability in the future, even if it hasn’t yet, as young, optimistic investors take increasingly daring risks on online trading platforms like Robinhood in hopes of getting rich fast.

In its semi-annual financial stability report, the central bank expressed understated alarm about the growing relationship between social media, online retail trading platforms, hungry new investors, and goosed-up stocks. While the report noted that dramatic swings in the stock prices of GameStop and AMC “did not leave a lasting imprint on broader markets,” it fretted  that such moments could harm both young, trigger-happy investors and society more broadly.

Generally Americans’ “risk appetite” is at levels not seen since it peaked around the time of the dot-com bubble, according to the Fed, and it’s young investors who are leading the online retail charge. The share of people under 35 who own direct stock has “surged” since 2013, according to the report. The Fed attributes the change to stock-trading apps like Robinhood, which offer zero-commission trading that is easy—for example, by allowing people to buy just a fraction of a share—and like a video game, due to little touches like “animations celebrating a user’s first stock purchase.” 

No surprise, then, that the average age of an account holder on a trading app is 30, and that half of them “self-identify as first-time investors.” This cohort of young and extremely online new investors trade in extremely daring ways. As the Fed notes, young investors take on more debt than the typical investor and are placing big bets with increasing frequency by investing in options, which allow you to guess if a price will go up or down in the future. 

Such risk-taking can help investors increase their winnings when things are good and the market keeps going up. (As Mark Cuban said last year, “Everyone is a genius in a bull market.”)  But it also could place them in a “more vulnerable” and extremely unenviable position, where losses can be dramatically amplified, should the market ever turn.  Stock prices have already increased “notably” in the back half of this year, and the ratio of those prices relative to earning forecasts are now nearing “the top of their historical distribution,” the report notes. 

Social media sites, like Reddit’s wallstreetbets community, could also, the report notes, allow excited new retail investors to create an “echo chamber” where people only interact with people with similar points of views and financial stakes, “thereby reinforcing their views, even if these views are speculative or biased.” That, of course, can help people collectively shoot GameStop’s stock price to the moon. It can also blind people to critical developments before it’s too late.

The Fed expressed concern that if the Molotov cocktail that is risk-taking online investors and social media echo chambers converging continues to grow ever larger, a “potentially destabilizing outcome could emerge,” particularly since financial institutions’ risk-management systems may not be adequately “calibrated” to withstand a collective loss of confidence. (This is all a bureaucratic way of people fundamentally charged with preventing catastrophe saying that they are pulling their hair out and running around setting it on fire.) 

While the Fed stopped short of saying any sort of actual action should be taken now, it did say that more “frequent episodes of higher volatility may require further steps to ensure the resilience of the financial system.” 

That’s Fed-speak for We might have to do something before wallstreetbets blows up the economy.