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‘We’re seeing the rise of the crowd’s power:” MIT professor on GameStop phenomenon

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Yahoo Finance’s Alexis Christoforous and Sinan Aral, Author The Hype Machine, discuss social media’s role in the short-squeeze frenzy.

Video Transcript

[MUSIC PLAYING]

ALEXIS CHRISTOFOROUS: For more on the Robinhood GameStop saga, I want to bring in Sinan Aral. He is a professor at MIT and author of "The Hype Machine." Sinan, good to have you here. You wrote a great op-ed in "The Washington Post"-- I'd encourage people to check it out-- about the herd mentality of social media and how it's bleeding over into the real world like never before. What are some of the long-term implications of that, do you think?

SINAN ARAL: Well, I think what we're seeing is the rise of the crowd's power in a number of different spheres in our society simultaneously. We saw it in the election, the aftermath of the election, where information flowing over social media was able to coordinate an insurrection, a riot, on the Capitol. And this was after we even had warning signs when there was a plot to kidnap and kill the governor of Michigan.

Now we see crowds that are raising again a coordinated effort to drive up the price of a stock. And let me be absolutely clear. I do not mean to draw an analogy between the GameStop stock price and the Capitol riot to say that there's even anything nefarious going on in the GameStop situation. It may be that nothing illegal was done at all in the GameStop situation. But the similarity is that when information moves so quickly and can coordinate so many people so fast, it scales the crowd's power like we've never seen before. And that is the similarity between the two.

ALEXIS CHRISTOFOROUS: You, know this isn't the first time, though, right, Sinan, that we've seen social media sort of inflate stock prices, create bubbles. We've seen pump and dump schemes happen on social media with misinformation and fake tweets and fake posts on Facebook. So why was the GameStop situation different?

SINAN ARAL: Well, I think a couple of things. So certainly in the past, when we've had misinformation used to pump stocks and then dump them, the SEC investigated and actually brought charges in those cases back in 2017, back in 2013 and '14. There were companies like [INAUDIBLE] and Dreamworks that were indicted by the SEC based on pump and dump schemes over social media.

I think the difference here is that the large short position of several major hedge funds made it enticing to see the stock price go up dramatically. And there was this narrative of the David and Goliath that made the story interesting. And there was a bandwagon effect that you might not have seen with sort of pump and dump penny stocks. Or it's easy to coordinate when there's a narrative that appeals to the human heart and when there's a short position that is vulnerable on the very dramatic rise of a stock price. So I think that was a big difference here.

ALEXIS CHRISTOFOROUS: What do you think might come of all of this in terms of regulation? Is the answer going to be, you think, to put more restraints on small investors, or will it be that there should be restraints on all investors and perhaps different restraints on short-selling and buying on margin?

SINAN ARAL: Well, I mean, I think that we need a thorough SEC investigation first. We're actually watching a plane crash, but the plane is still at 30,000 feet. It's not over yet. And I saw a tweet that said, I'm confused. Is it hashtag #holdtheline or hashtag #holdthebag? Because all of the holders can't sell their stock simultaneously. And it's very likely that the price is going to go down. And many people could be hurt in that process.

I don't think that we should jump to conclusions and create more restrictions in a knee-jerk fashion. We need to start with an investigation that understands who was in this crowd. Were there institutional investors that had ties to institutions? What were their positions? Was there any misinformation that was being spread in this process? Because that would potentially run afoul of the SEC.

I think there are two big risks here. When you untether the prices of stocks from the underlying economic reality of companies, there is the tremendous potential for instability. The second big threat is manipulation. If you thought Russia thought it might be productive to interfere in our elections through social media, imagine what they're thinking that they might be able to do now, given that you can change stock price outcomes by manipulating or talking on social media.

And we know that there are automated trading algorithms that are linked to social media that trade based on the sentiment. So you might not even have to get somebody to buy the stock. As long as there was talk about it, it could trigger algorithms that would trade algorithmically on the stock.

I think eventually what we'll need to do is, we'll need to examine, after an investigation, the relationship between communication about a stock and trading about that stock. We need guidelines on how we can communicate in ways that maintain stability. I agreed with your last caller, your last guest, who said transparency is important. That's probably an important part of it. But we need an investigation first.

ALEXIS CHRISTOFOROUS: For sure. A lot for the SEC to consider. Sinan Aral, professor at MIT, author of "The Hype Machine," thanks for your insights.

SINAN ARAL: Thank you.