“Determine your goals.” “Buy for the long term.” “Do your research. Buy quality.”
This week the boys in the basement inhabiting Reddit and the chatroom “Wallstreetbets” brought down staggering losses on the titans of Wall Street as millions of amateur investors showed the power of Main Street over Wall Street.
Make no mistake. That’s is what this is all about. It is the frustration of growing income inequality and feeling powerless. And those Reddit small investors decided to teach the big boys a lesson they would not soon forget.
Wall Street long ago turned into a casino. Most of the “investing” today playing the market, predicting which way a stock price will go and betting, in effect, on the outcome. The tools available include short selling and options trading. This is primarily the game of hedge funds, piles of money from rich people turned over to the professional Wall Street gamblers to play with.
Hedge funds look for opportunities to make a quick buck. They don’t “invest” in the classic mode as you do for your retirement. And this week they met their comeuppance at the hands of amateurs with a grudge.
Behold a company called Game Stop. This firm sells games and gaming equipment through brick and mortar stores; all of which are readily available on line, including Amazon. There is a Game Stop store not too far from me.
Remember Block Buster, once the center of Friday night entertainment?
Game Stop had been losing money over the past couple of years and its stock was languishing at $18 a share, The hedge funds smelled money to be made quickly and a prey ready for slaughter.
The funds began shorting the stock. They would “borrow” Game Stop shares on their own credit from a brokerage firm and sell them, promising to return the shares at a specific maturity. The shares would then be sold en masse with the affect of pushing down the price. The hedge fund would then buy the shares back at an opportune moment at the lower price to cover its position and lock in a profit.
Game Stop was eventually going to go out of business anyway so why not make some money on its lethargic stock?
Enter the “day traders”, the “retail market”, the “dumb money”, many with an axe to grind watching hedge funds rake in profits for essentially no risk. After all, they borrowed the shares that they sold, driving down the price, then bought them back, returned them to the supplying brokerage firm and pocketed the difference.
How to create infinite losses for them? Drive up the price so they can only cover their positions at great loss.
And so in the Reddit chat rooms the plan was hatched. Tens of thousands of those who read Wallstreetbets.com organized and began buying up the shares of Game Stop and the stock price began to rise. No one knew why but the hedge funds soon found out. The price went from $20 to over $500 briefly causing huge losses in the billions of the short transactions. Melvin Capital fund needed a bailout and was forced to borrow $3.5 billion to cover its position.
The stock sits today at $325 a share. Big loss for you if you shorted 100,000 shares at $20.
The frenzy has boosted GameStop’s market value $10 billion in recent weeks and revealed once again the casino culture that powers the financial industry. People on the r/WallStreetBets subreddit also have driven wild increases in the stock prices of other companies ― including AMC, Blackberry and Nokia, all of which were targets for shorting by the hedge fund firms. Of course many of the retail investors made large profits on their venture into Game Stock and began to sell causing the price to drop 64% resulting in a halt in trading for a time.
Meanwhile, Robinhood, which offers free trades to the Reddit groups decided to halt purchases of Game Stop through its portal and was immediately trashed. It was ok for the big boys to trade in Game Stop but as soon as the elites began to lose money the retail buyers were shut out.
Politicians from Warren to Cruz criticized Robinhood’s decision and it was quickly reversed.
As we sit today, a number of hedge funds have taken huge losses by closing out their positions or are facing huge losses when they go to do so. The SEC is “closely monitoring” developments with some clamoring for “regulation” while others point out that the market is open to all players.
Closely being looked at is the much easier availability of margin accounts to retail buyers which allows them to purchase stock on credit. Used to be a margin account was much tougher to get from your broker; now it seems if you open an account with Robinhood for free trades they practically give you a margin account line of credit. Robinhood makes its money selling your information to brokerage firms – and hedge funds. Certainly many of the Reddit day traders bought Game Stop on margin.
There are several reasons why Game Stop became the security of choice and the whole ordeal involves a slew of factors: Wall Street greed, financial instability, and the astonishing power of the internet’s collective will. GameStop has been called a “meme stock,” internet speak for a stock that was heavily influenced by people online.
Regulation may be hard to come by – is it ok for a hedge to gamble in the Wall Street casino but not allow anyone else to play? Why is there a Wall Street Casino in the first place? Those in the financial industry arguing for regulation to keep out the riff-raff sound like they are whining after facing some competition at the tables.
Certainly there is a new reality for hedge funds and a need for broader risk assessment.