You may have heard about the latest viral saga taking Wall Street by storm. I’m not typically into finance, but I’ve been following this story like a junkie and find it absolutely fascinating.
This isn’t my typical blog fodder, and if you’re not interested feel free to check out now. But if you’ve got a few minutes, and feel like humoring a market noob, let’s see how deep the rabbit hole goes…
So what’s going on?
The short answer is that a bunch of amateur traders are using social media to bust a billion-dollar hedge fund.
The long answer:
The whole movement started on a retail investment forum called r/WallStreetBets (WSB). Some savvy Reddit users figured out that a handful of hedge funds were overleveraged on a particular stock.
Wayyyy overleveraged.
These funds were trying to short GameStop into the ground.
GameStop is a brick-and-mortar retailer that employs tens of thousands of people around the world. Like most retailers, they lost revenue during the pandemic and faced possible store closures and layoffs.
Hedge funds sought to capitalize on this by betting against the company’s stock as they teetered on the brink of ruin.
Cynical. But fair in a free market.
Where they ran into trouble was when a few million Redditors decided to bet against them.
Here’s a layman’s view of what happened:
Several hedge funds borrowed shares of GameStop (GME) and resold them at the market price. At the time, the stock was trading under $20.
The plan was to buy the shares back when the price dropped, return their borrowed float, and profit off the difference.
But they got greedy.
Short sellers borrowed something like 140% of all available GME shares, putting themselves on the hook for more shares of the stock than even exist. It wasn’t enough just to short every GameStop share. They dug in deeper to short many of the shares twice.
Some folks at WSB picked up on this, and launched a viral campaign to start buying GME.
The idea was to trigger a “short squeeze”: A situation where investors hoard as many shares as possible, forcing short positions to pay a ridiculous premium to buy them back.
And it worked.
On January 4, GME price hovered around $17. As of market close Friday, it sits at $325.
Now the hedge funds that were planning to rebuy those shares cheap can barely get their hands on any, and whatever shares they could buy are sitting at a 20X loss. They’re between a rock and hard place, and as long as people keep holding there’s no easy way out.
The hedges can sit on their short positions for a while, but they owe regular interest on the borrowed shares. They’ve already lost billions of dollars, and they’re on the hook for billions more.
CNBC: GameStop short sellers not surrendering despite nearly 20 billion dollar loss.
So where does it go from here? Nobody knows.
These “naked shorts” expose the holder to potentially infinite losses. If Redditors can drive the price to 10K and hedges have to buy back 80 million shares? Well, you do the math.
It probably won’t come to that.
At some point next week, most people expect the hedge funds to run out of leash and start buying back overpriced shares. This will create a self-reinforcing cycle that drives the price higher and higher as there simply aren’t enough liquid shares to go around.
The endgame could bankrupt multiple hedge funds and make new millionaires overnight.
Depending how wild it gets, the ripples could cascade across the stock market and impact banks, brokers, insurance companies and more.
The government could even step in and just shut the whole thing down: bailing out the hedge funds or brokering a deal that forces all parties to walk away.
I’m probably talking over my head here.
But I can tell you from reading WSB forums the last few days that these people are FIRED UP. I can’t remember the last time I saw this much solidarity and enthusiasm from an internet community. I’ve seen kids post about scraping together a fractional share to be part of the fight. Others claiming 100K investments or million-dollar profits that they won’t cash out until some hedge fund bends the knee.
Fair or not, hedge funds are a bit of a boogeyman amongst the retail investment crowd. They are typically reserved for high-net-worth individuals, requiring at least a million dollars just to walk in the door.
They then have access to all kinds of fancy financial instruments: options, derivatives, shorts, leverage… The populist cynic in me calls it a rich-man’s gamification of the market. You can call it whatever you want.
The point is, they make big bets and big profits, often playing both sides to “hedge” against unexpected moves.
Again, you could call this savvy investing. Smart money. A necessary evil. But what it often amounts to is when stock prices go down, and average Joes get burned, hedge fund millionaires walk away with more profit.
This is in part what happened during the 2008 crisis. Institutional traders overleveraged risky mortgage securities into complex derivative trades. When the bubble blew up, the housing market crashed and dragged everything else down with it.
The ensuing recession took years and billions of bailout dollars to recover. Even so, at least one savvy hedge fund made a fortune shorting the housing market just before the crash. They made a movie about it.
In browsing WSB forums the past few days, I’ve seen a lot of callbacks to 2008, and cries for revenge against the risky financiers who tanked the economy for everyone then got bailed out anyway.
Now I could be wrong about all this. Someone with ten minutes of business school could probably set me straight and I encourage you to do so.
I just find the whole saga fascinating.
It’s this perfect intersection of runaway capitalism and crowdsourced resistance. Once the story went viral, people around the world started opening brokerage accounts just to buy GME shares and stick it to the man.
Things got even more intense when the hedge funds and their allies tried to fight back. They launched smear campaigns against WSB and spread disinfo across the media.
Several popular investment platforms started delisting GME and other viral short squeeze targets. This was decried as market manipulation, and there are already calls for class action lawsuits and Congressional hearings.
Independent: Robinhood faces backlash after stopping purchases of GameStop
These hedge funds are backed into a corner, and every time they lash out it just fires up the crowd. Thus is the unpredictable power of the internet. #EatTheRich.
The best part of all this? It’s. Not. Political.
Good God, what a relief. After years of partisan bullshit and contrived culture wars, this is a story where left and right seem to march in lock step. Politicians, celebrities, and icons on both sides of the aisle are coming out to voice support for small-time traders going up against big-money gamblers.
This comes at a time when wealth inequality is at historic levels, and millions see themselves as victims of a system rigged in favor of the rich.
U.S. billionaires made over a trillion dollars during the pandemic, while millions of people lost their livelihoods.
CBS: U.S. billionaires gained almost $1 trillion in wealth during the pandemic.
April 2020 saw record unemployment while the Dow Jones had is best week since WWII.
Sitting senators dumped stock after private Covid briefings, and nobody did a damn thing.
NYT: Justice Dept. Ends Inquiries Into 3 Senators’ Stock Trades
The list goes on and on, yet none of these absurdities led to meaningful reform, or even serious discussions in the halls of Congress.
We can’t even get a proper stimulus check.
But now there’s talk of regulating Reddit, or protecting billionaire hedge funds from an “online mob”.
It’s no surprise people feel betrayed, and they’re relishing this opportunity to take Wall Street by the balls.
Maybe this is the start of a new movement. Occupy Wall Street 2.0. The Great Class War of 2021.
Or maybe this will all blow over in two weeks and we’ll be on some different meme.
What I know is this: I jumped in my brokerage account the other day and bought a few shares of GME.
Win or lose, I’m part of this now.
For the people. For the principle. For my kids.
Let’s squeeze the shorts dry.
Diamond hands.
Disclaimer: This is not financial advice. I’m just some dude with a blog. I own several shares of GME as stated. If you really want to fight the system, buy Bitcoin.
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