Only someone living under a rock hasn’t heard about the GameStop stock market shorting scandal. While the mechanics of the stock market battle are interesting, they’re nothing new. What’s new is this: The battle this time is being waged by Deplorable America vs. Elite America. And Elite America isn’t at all happy about it.
It’s well known that the stock market isn’t controlled by small investors, but by massive financial institutions. Recent data show that mutual funds, pension funds, hedge funds, Wall Street investment banks, public pensions and the like control more than 80% of all shares traded. They are always the elephant in the room.
The little guys with trading portfolios of less than $100,000 or so, often operating online at lightning speed on no-commission trading sites – such as Robinhood – have a small piece of all the trading. They win only by exploiting cracks in a system dominated by big firms.
Which makes it all the more amazing that they were able to take out a major hedge fund with a short position in GameStop, a troubled chain of computer gaming stores that still has a big following on Reddit.
First, in case you don’t know what “shorting” a stock is, it’s basically borrowing a number of shares of a given stock to sell at the current price. The borrower sells the shares, then promises to pay back the lender the same number of shares at a later date.
Short investors do this because they expect the stock to go down. If it does, they can buy back the borrowed shares at a much lower cost. The difference between the original selling price and the buyback price is the profit.
An example would be someone shorting 100 shares of a stock now trading at $50 a share. If the stock plunges in the following weeks to, say, $30 a share, that person could buy back the 100 shares and pay back the lender. The result: A nifty $20 per share profit, or about 40% of the initial investment.
But what if the stock rockets up instead? In that case, the person holding the stock could theoretically be on the hook for nearly unlimited losses as the stock soars.
On Wall Street, it’s not unusual for one fund to make another fund with a short position miserable by driving up the price of the stock. It’s a brutal bit of financial warfare known as a “short squeeze,” and it happens all the time.
What’s different about the short squeeze for GameStop stock is that it’s not big institution vs. big institution, but a bunch of no-name market guerrillas operating on a Reddit sub-feed called WallStreetBets that caused havoc among funds that had taken hefty, and very risky, short positions in the slumping GameStop. Most prominent among them was Melvin Capital.
Melvin was founded by Gabe Plotkin, a former star portfolio manager for hedge-fund titan Steven A. Cohen. It started the year with about $12.5 billion and now runs more than $8 billion. The current figure includes $2.75 billion in emergency funds Citadel LLC, its partners and Mr. Cohen’s Point72 Asset Management injected into the hedge fund last Monday.
Do the math, and that means Melvin lost close to 58% of its capital in one brutal, ruinous month of trading. All because an online group got tired of seeing its own stock go down due to short-selling, and decided as a group to buy the stock instead. As GameStop share prices rose, the short-sellers got hammered, and their losses were immense.
GameStop could be bought for $19 a share on the first day of trading, Jan. 4, of this year. It closed above $325 a share on Friday. Those who shorted the stock on Jan. 4 now face a $311 a share loss on their investment.
Only on Wall Street do those who make mammoth mistakes by taking huge risks get bailed out. If you’re a little guy, like the Reddit gang, your losses are your own. Good luck.
That’s why it’s no accident that the stock market finished down sharply late last week. As economist and investment advisor Ed Yardeni, one of the sharpest minds on Wall Street, noted:
The shorts have the fundamentals on their side, while the Gamesters can band together and play Robin Hood and His Merry Band with their commission-free Robinhood accounts. As a result, “flash mobs” can now occupy Wall Street at any time. This social media phenomenon allows groups of people to be summoned by message boards, email, and text messages to a designated location at a specified time to perform an indicated action before dispersing.
Or, as Reason put it, “This was a meme-managed, crowdsourced effort to exploit a quirk in the financial system, to test its limits, and, in a way, to break the game.”
True enough. But you can’t blame social media entirely for this, since big funds mucked with the markets to their own advantage in the 2000 dotcom bubble, the 2008 housing and financial meltdown, and from 2010 until today with program and algorithmic trading systems that often overwhelm small investors. And that game goes on.
Perhaps more significantly, the stock market populism risks a huge overreaction from elite, leftist, insider Washington, D.C., which fears a steep market downturn could risk its plans for perpetual rule.
That’s why much of official Washington wants the Securities and Exchange Commission to “do something,” as the saying goes. Never a good sign.
Former SEC Commissioner Laura Unger last week even described the small-investor Redditor group as “Not unlike what we saw on Jan. 6 on the Capitol. If you don’t have the police in there at the right time, things go a little crazy.”
Meanwhile, Senate Finance Committee Chair Elizabeth Warren has also called for an SEC investigation, while House Speaker Nancy Pelosi wants Congress to hold hearings. And a number of online trading platforms, including Robinhood, shut down trading on GameStop and dozens of other “volatile” stocks, in effect giving the stocks nowhere to go but down.
And please don’t misunderstand: We’re not against shorting the market. It’s the best way to make sure there are ample buyers when stocks do fall. But that’s not what this is about at all.
Instead, it’s really about politicizing markets, always a danger. Politicians, especially on the left, talk a good game about protecting “the little guy,” but in the end, they always side with the big guys. Why? Because, contrary to the political myth widely propagated by the big media, the Democrats are the party of Wall Street — not the Republicans.
We saw that clearly in the most recent election, when securities and investment firms delivered $74 million in campaign donations to support Joe Biden, more than four times the $18 million given to Trump, according to the Center for Responsive Politics. And they gave even more to Hillary Clinton in 2016, a cool $87 million.
“The little guy” is nothing but a prop. The Democrats are already bought and paid for.
Yes, the stock market needs to have rules. And it does. What it doesn’t need is ad hoc political intervention by the SEC, Congress and the White House to engineer desired outcomes.
We suspect what really terrifies the leftist Democrats who now rule D.C. isn’t short selling at all. It’s the idea that their BFFs on Wall Street got a glimpse of the Biden administration’s anti-growth tax, and spending and regulatory policies, and are having second thoughts. If so, the stock market could be in for a very bumpy ride, and the SEC won’t be able to a damned thing about it.
— Written by the I&I Editorial Board