The Battle of GameStop

If you ever want it explained to you about Wall Street or unregulated capitalism, I find it helpful to refer to gangster movies.

Want to understand how insurance works? Watch Goodfellas.

Want to understand hostile takeovers? Watch The Godfather.

Want to understand corporate espionage and insider trading? Watch The Departed (or an actual movie about Wall Street crimes, Wolf of Wall Street).

Want to understand shorting stocks? Here's the opening bit to Miller's Crossing:

It's gettin' so a businessman can't expect no return from a fixed fight. Now if you can't trust a fix, what can you trust? - Johnny Caspar

What's happening in the real world is that the stock markets are reeling from a running gambit that hedge funds (Think billionaire vultures) had been using of "Shorting" the stock value of a retail company GameStop (Remember Blockbuster Video? GameStop is kind of like them but selling video games instead of movie rentals) for quick profits, only to get exposed by Reddit (social media) investors realizing those hedge funds overextended themselves (took on massive debts to pull off the Short) to where they were vulnerable to "Squeezing" (artificially raising the value of the Shorted stock so that the hedge funds can't turn a profit).

In short: The hedge funds are Johnny Caspar trying to make money off a fixed fight, only for Bernie (the horde of small investors) to flip the fix to make money while Caspar eats the losses.

For more details, let's go to Derek Thompson at The Atlantic for his take:

...To see how the whole thing went down, imagine a kind of misshapen nesting-doll set with four characters: GameStop, hedge funders, Reddit traders, and zillions of retail investors.

At the center is GameStop, which is not a great company. In 2019, the strip-mall fixture lost almost $500 million. In 2020, a pandemic forcibly shut down many of its stores and gutted its revenue...

I don't blame GameStop: they didn't ask to get Shorted by the big hedge funds like Melvin Capital (wait, seriously, they named themselves Melvin??? What the hell, was "Eagle Fang" already taken or something?).

One layer up, you have institutional investors, such as hedge funds, which “shorted” GameStop, or bet that the value of the stock would decline. Depending on how you look at it, short sellers are heroes of capitalism identifying rotten companies and industries on the verge of collapse, or they’re corrupt worrywarts picking on lovable, vulnerable firms. Either way, GameStop was one of the more popular targets of these hero-villains. By one metric, the company was the second-most-shorted firm out of more than 6,000 companies listed in the New York Stock Exchange and Nasdaq. If GameStop’s stock continued to fall, as it had consistently since 2013, hedge funds that had bet against the company would have gotten even richer than they already are...

Thompson doesn't seem to recognize the pattern of rich-brat bullying underlying the way the hedge funds were picking on GameStop. I highlighted the part he's ignoring as a sign that Melvin and the other investment groups weren't using Shorting tactics to weed out bad companies: The hedge funds enjoyed having an easy target like GameStop around to Short in order to generate billions in profits with little risk (because Shorting is a fixed fight). But risk did show up:

But they didn’t. That’s because, as short sellers were targeting GameStop, online investors were cooking up ways to target the short sellers. A band of Reddit users, led by a trader who goes by the YouTube name “Roaring Kitty,” had for months been eyeing GameStop as a tasty investment. Over the course of several months, they spelled out a detailed plan to buy up GameStop’s stock and push up the price, punishing the hedge funds and forcing them to cover their position by rushing to buy back shares, which would push up the stock’s value even more. This is called a “short squeeze,” and it seems to have served at least two purposes for the Reddit investors: sticking it to hedge funds and getting a little rich. Both happened. One hedge fund, Melvin Capital Management, has lost at least $2 billion, while Roaring Kitty is now estimated to have made more than $13 million on his GameStop investment...

What happened at the social media level was akin to a revolution, a sort of Occupy Wall Street where instead of protesting in the streets the lower rungs of society entered the trading floor to beat the rich kids at their own game. It not only brought about financial ruin for Melvin (with rumors of filing for bankruptcy because its debts on those Shorting deals are due soon) but sent much of Wall Street into a collective panic. If the day traders and middle-class self-taught investors can spot a Short taking place, any quick-rich plan to Short a company for billions is now at risk of getting Squeezed. Back to Thompson:

Maybe the only long-term outcome of the GameStop fiasco is that hedge funds will be more cautious about establishing enormous short positions in cheap brand-name companies, and investors will learn that stock manias, like memes, disappear as quickly as they go viral. Perhaps all we’ll remember from the past week is that a few hedge funds’ greedy doltishness accidentally helped mint some Robinhood millionaires, while a bunch of latecomers set their money on fire for lolz.

But something tells me that we’re at the dawn of something stranger. For a week, takes have flown wildly around the internet that tried to capture this saga in a tweet. The investor and former Trump White House communications director Anthony Scaramucci compared what we’re seeing now to the “French Revolution of finance,” with an army of scrappy traders engaged in a moral uprising. Others worried that the GameStop bubble was turning into a collectivized Ponzi scheme, in which innocents were being lured into a ruse that would take all their money after the market corrected. Given that online trading has been restricted and the company’s stock is now in a free fall, both the Mooch and the Debbie Downers might be right...

What Thompson refers to is how Robinhood, the brokerage site that started this Squeeze play, stopped all trading on GameStop and other Shorted stocks like AMC Theaters, preventing the investors from doing what they wanted (to either sell themselves before the artificial high prices dropped, or to buy even more to squeeze the hedge funds into full bankruptcy). That freeze turned a revolution into a meltdown, leading to one class action lawsuit already. There's a likelihood the Squeeze was as rigged as the Short.

We're witnessing in real-time the public exposure of one of Wall Street's greediest tricks (market manipulations) at the expense of the common ground-floor investor getting screwed either way.

In some respects, it's a damn good thing there are reform-minded Democrats now in charge of Congress to investigate this whole shell game. Have at 'em, Liz Warren and Maxine Waters. I hope you root out the whole rotten gang of greedheads.