The days, weeks, and maybe months ahead will reveal bits and pieces of last week’s attempted trading coup, filling gaps in our collective understanding of what took place, in just one more crazy story of a bizarre year. At present, the press and pundits have flooded the airwaves with versions of a history based loosely around a reality that may never be fully understood. The most popular narrative appears to be that of the individual, everyday heroes decimating the avaricious hedge funds and Wall Street fat cats that have destroyed our economy through financial misdeeds. It’s a sensational allegory, and perhaps that is why the public embraces it so eagerly. But is this really what happened?
Looking at the finer details of the story, it helps to try and separate fact from conjecture. A few aspects of the narrative appear certain to be true:
1. Some hedge funds lean heavily on short selling of stocks that they think are likely to go down in an attempt to net a hefty profit.
2. Some Reddit users banded together to bolster a couple of these stocks (most notable GameStop and AMC Entertainment) by encouraging group buying to squeeze the short sellers out of their positions.
3. The Reddit strategy worked temporarily in that the selected stocks were rapidly pushed higher forcing many over-leveraged short sellers to cover their positions, thus driving the equity prices even higher.
4. One notable hedge fund, Melvin Capital, suffered severe losses, and were bailed out by Citadel (another hedge fund) to the tune of $2 billion.
5. Marketwide volatility quickly doubled.
6. Robinhood and other online brokerages tightened restrictions, and in some cases, prohibited trading in certain equities and options classes.
Everything else is either speculative, or remains to be seen.
The bare-boned facts don’t make for much of a story, and those unfamiliar with the events leading up to this debacle might be easily swayed by any juicy conjectures that can crudely arrange the facts in a way that makes even a lick of sense. I’d hate to be left out of the fun, so here is my translation of “GameStopGate.” Enjoy.
“Never a dull moment”
While the cliche may perfectly describe last week’s market activities, anyone who has spent time in the finance industry will tell you that in general, nothing could be further from the truth. Most time spent on a trading floor consists of endless price quoting, position checking, and cropping together a collection of small trades in which there are more winners than losers.
In “grey-suit” finance like investment banking and hedge funds, where people spend more time working than goofing off, the traders and managers fill downtime with more work. If the boredom becomes too much, they work harder still. Similar to most high-level professions, the majority of the work consists of unremarkable tasks, a great deal of repetitive procedures, and a fair bit of tedium. Real experts spend years studying their field and honing their craft in the hopes that when those few crucial situations arise, they can handle them and perhaps even learn and benefit from them. Bad for cheap Hollywood pulp hyperbole. Good for real life. No intelligent person wants their broken leg treated by a “doctor” who spends most of his day swapping internet ER memes in chat rooms and blasting out emoji-laden tweets about the latest in medical research. There is a somber, mundane working to our modern lives, that while not sexy, does prevent our society from devolving into utter chaos.
So when a hedge fund filled with true professionals decides that the prospects for a business that deals in second hand, soon-to-be relics, are not good, the choice to take a short position in its security might just be smart business.
Then again, it might be something foolish or even downright sinister. Greed, arrogance, potential past-malfeasance…they are not a group of attributes that can’t coexist with brilliance and dedication. But, with the growing gap in American income and wealth distribution, a lot of people might be inclined to believe that nefarious intentions played a bigger role than intelligence and hard work in large hedge funds taking short positions in ailing companies. The workings and true nature of financial markets evade the average citizen, especially when strategies beyond basic buying and selling of common stock come into play. Add these factors to the mishandling of the housing market crisis of 2008 when the government bailed out the banks instead of the country, and all of a sudden, the majority of American citizens believe that the system is rigged. To a degree, I also believe this to be true.
Although I can’t prove it, my first impulse is to believe that the Reddit bunch and the late additions to their buying posse share these sentiments. With nothing but time on their hands and stimulus checks in those, they set out to claim a small victory for the “little guy,” and if they pocketed a neat profit along the way, who am I to complain?
Then again, it’s not a stretch to believe that the main orchestrators of this movement were well aware of the negative externalities. Taking a shot at a big bad, well-capitalized firm is one thing — in this case, the stated objective. If trying to rectify suspicious market behavior by countering with your own suspicious market behavior is the goal, that is of questionable integrity and efficacy, but we have a solution for that in the market itself. The bigger problem comes with the knowledge that many of the people that you have recruited to join you on this crusade will inevitably lose money, maybe a lot of it. As the Redditors drove (drive) the price of GameStop through the roof, there were (will be) plenty of hapless punters who bought (will buy) near the top ($483) only to watch that “investment” collapse to a fraction of the purchase price. If you think actually being near $483 matters in this example, consider the fact that the opening price today was $316. It closed this afternoon at $225.
Part of the considerable interest in short selling stemmed from the fact that so few investors actually wanted to be long (own) the stock in the first place. The company appears to be an encyclopedia salesman in a world of Wikipedia, not to mention that their other fundamentals look pretty weak. None of that has changed. When the speculators who drove the price of GameStop up look for an exit, the real investors will likely wait until the stock returns to a price more appropriate of the company it represents — say somewhere around $20…let’s be generous and call it $50. It still has a long way to fall.
Whether any or all of this comes to pass cannot be foretold with certainty. However, I doubt that many of the Reddit Army truly thought this through. Why? Because they are unlikely to have put in those long, boring tedious days that only pay off in the long run like the true professionals I spoke of earlier. Real analysts and traders are doing their research and writing their reports, not wasting time trying to find which emojis will play well in the Twitterverse. The pretenders sought a quick thrill, a quick buck, or a way to “stick it to the man.” I believe they got the thrill — good or bad. More than a few made a quick buck as well. What about sticking it to the man?
If the man in this case is Melvin Capital, then the answer is yes — if only briefly. Melvin Capital scrambled to close their shorts, incurred massive losses, and were made to look the fool. However, they reportedly received a $2 billion vote of confidence from Citadel, aggressively deleveraged themselves — thus strengthening their liquidity — and still have somewhere near $4 billion under management. And that’s just the firm. According to Forbes, in 2017 alone founder Gabe Plotkin earned around $300 million for himself. I’m guessing that being a financier by trade, even if Reddit had succeeded in vanquishing Melvin Capital, Mr. Plotkin would still be scraping by. Will Redditors who took a bath be saved by their fellow soldiers? Unlikely. The Army appears to have moved on to their next battlefield — silver. I read a couple blurbs insinuating that this time around the targets are the banks. Sure, why not? The battle plan that failed to sink an $8 billion dollar hedge fund should have no problem tackling the likes of JPMorgan Chase and Merrill Lynch. Godspeed.
Then there are the other extant hedge funds that probably took advantage of the resultant volatility and opportunities for trading, both in the targeted stocks and the market at large. How well did they do? What did they do? My guess is that we will never know, as they are unlikely to feel the need to broadcast it to the world. They leave that for the experts on /r/wallstreetbets. Big hedge funds didn’t get to where they are now with a bunch of bucketheads, so you can be sure they’ll be watching Redditors from here on out, looking to cut them off at the knees as they formulate future plans.
So, before we award the Reddit Financial Wizards a slew of Presidential Medals of Freedom for excellence in blogging, perhaps we need to take into account how many of their own foot soldiers they foolishly lead to slaughter. The prevailing story in mainstream media might very well become reality, but I have my doubts. This looks more and more like the definition of a pyrrhic victory.
American financial markets need serious reform, but they will not occur as a result of faceless amateurs drawing up wild schemes to bring the bad guys to their knees. Some of the players on Reddit surely made a fortune over the past few days, and I give them credit for an impressive speculative play in markets that had become severely unbalanced, but to regale them as heroes just doesn’t work. The reality is, some little guys made money, some lost money. Some big guys made money, some big guys lost money.
As for the good guys and the bad guys — you have to first decide who they are. Most of the time, as in this instance as well, each side owns a few of both. However, in our present-day fables, we often try to paint the major players in facile caricature. People have an easier time digesting these stories when the protagonists only embody positive traits and the antagonists only bad ones. That level of simplicity may be comforting, but it can turn what might be a great teaching moment into a fairy tale more appropriate for children than adults who should know better.