GameStop: An Explainer
Oscar: “It sounds like a get-rich-quick scheme.”
Michael: “Yes, thank you! You will get rich quick. We all will!”
- The Office
Human history is filled with people looking to make a quick buck. As the old saying goes, “money won is twice as nice as money earned.” The inescapable gravity of the GameStop story has pulled the attention of seemingly everyone. While the actors in this play might be different, the story is familiar. Now, what is happening and more importantly, what should you do about it?
This story is being pitched as the little guy vs the big guy. In one corner, we have Reddit users. For those unaware, Reddit is an online message board where people with similar interests congregate and share ideas, answer questions, or talk out of line (it is the internet, after all). The players in this game come from one section of Reddit, titled “Wall Street Bets” which is dedicated to investing (I use that term loosely). In the other corner, we have short sellers. As a refresher, shorting a stock consists of borrowing a stock from someone else and selling that stock with a promise to buy it back later to return to the original owner. In a perfect world, the stock you sold declines in value and you buy back at a lower price. Buy low and sell high in reverse. The challenge with short selling happens once the stock starts to go up in price. Because you are paying interest on those borrowed shares and posting collateral to ensure that you have the money to buy the stock back, things can get pricey. At a certain point, short sellers cry “Uncle!” and buy the stock back. This causes the price to go higher and unleashes a vicious cycle for remaining short sellers referred to as a short squeeze.
The genesis of the Redditors’ focus on GameStop is not important, but what is important is that they all collectively decided to buy a stock with a large percentage of their shares lent for shorting. A few prominent hedge funds got caught on the wrong side of this and their losses on the trade were in the billions at last check. As an aside, I find it fascinating that so many people would be willing to trust a group of strangers to act in a coordinated manner to make money. If too many of them bailed early and took a quick profit, this would probably be a non-story. Again, this is nothing new. In the late-70s, two brothers from the Hunt family (current owners of the Kansas City Chiefs) collaborated with the Saudi royal family to corner the silver market. This entailed the attempt to buy a majority of the world’s silver to a point where they could dictate the price at which it was sold. Prices rose from $6/oz to $50/oz, but regulators quickly stepped in and the bubble popped. The novelty of our current situation is that the tables are turned in the eternal battle of Wall Street vs Main Street. This isn’t J. Pierpont Morgan and cronies concocting a market manipulation scheme in some dimly-lit cigar room – it’s more like a cackle of hyenas overtaking an elephant.
The moral dilemma here is what to do about this. Wall Street is scrambling and certain brokers are restricting trading which has elicited cries from the populace about fairness and equality. The thinking goes, if Wall Street firms can make money hand over fist by pulling the wool over the eyes of a retail investor, why is it prohibited to take a hedge fund to the cleaners? Nobody is shedding a tear over some hedge funds closing down, but I’d be willing to bet that more than a handful of mom and pop investors got swept up in this maelstrom. The fear of missing out can provoke people to do some irrational things such as putting hard earned money into GameStop at nosebleed prices. I’m sure there will be some regulation borne out of all this, but that is above my pay grade. What should you do about all this? Nothing except maybe sitting back with some popcorn to watch the spectacle.
Author: David Rath, CFA
Feedback? Drop us a line!