Guest Post by Andrew Nelson and Rich in Ct, with a note by Humble Talent
[I would say that finance is among my worst topics along with soccer and calculus. My request for clarification on the current GameStop controversy and its ethics implications attracted helpful responses, and I am combining them into one collaborative post. First, Andrew:]
Gamestop, a publicly traded company, was seen as undervalued by some users of an internet forum, in this case, a reddit forum called r/wallstreetbets. That same stock was seen as on the brink of collapse by a hedge fund management group, Melvin Capital, who decided to short sell….
Here Humble Talent clarifies:
A short sell is when someone, usually a broker, is holding stock in a company they think is overvalued. They owe their client X number of shares, regardless of the price. So if you have 100 shares of Game Stop stock at $4, and you think it’s going to $2, you sell at $4 and then rebuy the stock at $2, pocketing the difference and letting your client swallow the loss. It’s a loss they would have swallowed one way or the other, so they’re not really hurt, per se. Basically, you’re betting that a stock will go down in value. If the stock instead increases in value, you lose the difference. I think it breaks a fundamental fiduciary duty and should be illegal, but it’s where we are.
So what happened here was that a lot of people thought Game Stop was overvalued, it was listed at approximately what I said it was, between $3 and $4 per share. Short sellers were banking on it decreasing in value, so they sold all their client’s shares. Now that there’s been a ridiculous noise buy on these stocks, and they’ve *increased* in value 1000% (real number) instead of decreasing 50% (expectation) the firms that short sold the stock are going to have to find stock to buy to make their client’s portfolios whole. Which means that they will have to buy thousands of shares back at $400 when they sold them at $4, instead of $2, which they expected to. That 2000% difference over all those shares represents tens of millions of dollars, just on the Game Stop shares.
Basically, a bunch of unethical portfolio managers got their paws slammed hard in the cookie jars of their client’s portfolios, and it’s magnificent.
….Whether through intent or accident, these two groups converged on Gamestop at roughly the same time.Regardless of original intent, the users of the reddit forum got more and more people to buy into that stock, causing the price per share to inflate drastically. It’s sitting at over $400 per share when I last checked. A similar situation is happening with AMC stock, though with less drastic inflation.
Now, when Melvin Capital’s option reaches its end, they’ll have to return the shares they borrowed along with all that money per share above which they initiated the short sell. This would cost the firm billions due to how many shares of Gamestop are involved and the drastic increase in share price.
Earlier today, several stock trading apps, including Robinhood and T.D. Ameritrade stopped allowing users to buy Gamestop, AMC, Nokia, and Blackberry (though I don’t think the last two were being massively inflated at the time). Also, Discord, a popular messaging app, removed r/wallstreetbets from their app, allegedly for spreading hate speech. All these moves are seen by many people, regardless of political views, as terrible actions designed to punish common people for figuring out how to make some money while a multi billion dollar firm loses out for betting that a company would fail.
The basic questions, as I see them, are:
- “Is a private company allowed to stop people from buying a stock?”
- “Are a group of people talking in a public forum about which stocks to buy and why an illegal action (the SEC is trying to determine this as well)?”
- “Is it right to inflate a stock for the purpose of causing a hedge fund to fail, if that hedge fund and/or others have done similar things to stocks in the past that have caused people to lose money?”
Now more perspective from Rich in Ct….
Near as I can tell, what happened is that users on a Wall Street “sub-Reddit” colluded to manipulate the stock market to harm institutional investors, and many more collaterally. Some of those users made a lot of money in the process of punishing the institutional investors for doing the same. Others bought into GameStock bubble just before it burst, and lost quite a lot.
The activist investors from Reddit noted that big hedge funds were attempting to “short-sell” the stock in failing videogame seller GameStock. The hedge funds sold thousands of shares of stock, and were contractually obligated to buy them back after a certain amount of time. They figured the store would go out of business, and they’d be required to buy back worthless stock, keeping the proceeds from the original sale as profit.
Some Redditors decided they believed in the company, and began buying up GameStock on the market. This caused the price to rise, and forced the hedge funds to buy back stock at a higher price than they sold it for.
Then it became personal. Redditors dumped their life savings into the GameStock. They wanted to cause the hedgefunds as much pain as possible by driving up the sales price. Due to convoluted trade structures, hedgefunds sold more stock than actually existed, forcing them to buy, resell, and buy the stock repeatedly, driving the stock price up 100x its pre-manipulation price. Trade platforms that make it easy for individuals to buy stock suspended trading GameStock, which has slowed the violent price fluctuations.
Some activists were believers in the GameStock. Some wanted to stick it to “the man.” Others were just excited to be part of something.
The stock market relies on rational economic theory, which posits that people will only act in their best interests. “Sticking it to the man” is not a rational strategy. People were will willing to take extreme risks with their own livelihoods on this stunt. One individual took his savings, current month’s income, and paid all his expenses on credit to “make it hurt” for the billionaire -owned hedge funds.
While it might not necessarily be unethical to risk one’s wealth chasing windmills, this event will cause collateral damage to many. Most hurt are individual investors hoping for GameStock to rebound. Their participation was prior to and without knowledge of Reddit’s shenanigans (although investing in a failing company is always a gamble). Then there are the fools and knaves who got excited and threw money at this – the slot machine was blinking, and they pulled the lever. They are victims, but do bear blame for knowingly participating in something they don’t understand. Arguably, the smart people who knew enough about the system to upend it bear much of the blame for making the world a more cynical and ignorant place.
“We did it, Reddit!”
Moreover, the stock market relies on good faith participation. Indeed, democracy itself relies on this. Individuals who collude to screw over big bank investors are no better than those they claim to be sticking it to. The FTC was created to reign in the most egregious of institutional manipulation of the markets. Investment funds continually push the limits, but no system can survive a ground swell insurrection from within.
Where ethics fail, the law steps in. The security of our nation’s capitol requires citizens to voluntarily not storm the gates. Only overwhelming force, antithetical to a democratic society, can protect the Bastille from falling. The free markets cannot survive individuals taking it upon themselves to screw around for the sole purpose of harming others.
The GameStock saga is ultimately an unethical stunt. Individuals abused their freedom to participate in the markets to harm others, unironically to harm institutional investors who they believe hurt the little guy. There are two options to respond: trust that individuals will behave in the future or barn door regulations that limit individual participation. History suggests the latter.