I’m sure that most people have heard about the GameStop trading “scandal,” and are mainly aware that some people made a lot of money from it, while others lost a lot of money. The people who made a lot of money were the original investors who had shares that were priced low, and were probably going lower. Those who cashed out when their shares skyrocketed beyond their wildest dreams are obviously very happy about went down. The people who were not happy were mostly hedge fund managers who don’t really contribute anything to the economy, but just play around with money, finding “creative” ways to inflate its value. Unlike normal investors who buy stock in the hope that stock prices will go up, what these pirates did was “bet” that GameStop’s share prices would continue to go down, since it is just another storefront retailer losing business to Amazon.
What they did was what is called
“short selling.” Instead of buying stock shares in the expectation that prices
will go up, they “borrow” shares being managed by a financial services broker.
In a way this could be understood as “borrowing” money from a bank, with the expectation
of repayment of the loan with interest. The “borrower” has to provide some sort
of collateral or deposit, known as a “margin account.” The expectation of short
selling is that the price that the “borrower” eventually must pay for the shares will go down; if the initial
price of the stock was $100 a share, and the price declines to $50, then the
“borrower” is allowed to complete the purchase of the shares at that price, and
keep the difference. It is like borrowing $100 and only being legally required
to pay $50 of it back.
It is all seems rather shady
business, which is what the financial sector essentially engages in on a daily
basis. But if things go wrong for the short seller, they can go horribly wrong,
as it did in the GameStop episode. It seems that dedicated gaming enthusiasts
who didn’t like what was going took the advice of the Reddit board
WallStreetBets and decided to play their own little “game” with the short
sellers. Utilizing the trading companies like Robinhood for “high-speed”
investing, a flood of people with a little cash to blow started buying GameStop
shares, the price of which ballooned 1,500 percent in January.
Short sellers took a bath, losing
$13 billion, being forced to pay for their shares at wildly inflated mark-ups.
As in the previous example, it is like borrowing $100—but then having to pay
loan shark interest rates, in this case potentially 15 times what they would
have owed at the original price. Some
short sellers who couldn’t complete payment for their shares quick enough found
themselves buying more GameStop shares to keep from taking complete bath,
causing the share price to rise even further. The real winners were those who
already owned GameStop shares, which allowed many to cash-out with previously
unimaginable profits. Robinhood decided that this had gone out of control and
stopped the trading in GameStop, which caused the company to quickly lose
value, but Robinhood has since lifted trading restriction, and the share prices
of GameStop have rebounded somewhat.
There are those who claim what
the “little” investors did was an irresponsible manipulation of the stock market,
but “big” investors have been manipulating prices for a long time, especially
in the financial sector. The infamous Enron scandal involved that company
manipulating energy supply in California in 2000, causing massive price hikes
by creating artificial shortages that were allowed to happen because of
Republican Gov. Pete Wilson’s energy deregulation program a few years earlier.
Financial deregulation passed during the Clinton administration led to the
Great Recession, when banks that held subprime mortgages that they knew would
soon be worthless, packaged them as Collateralized Debt Obligations (CDOs) and
sold them in the unregulated “shadow banking” market, where we saw terms like “derivatives”
and “credit default swaps” come into the financial parlance. During
congressional hearings, bankers who engaged in these practices showed little
contrition for the damage they caused.
The GameStop saga has been framed
as the “big guys” getting a taste of their own bad medicine from the “little
guys.” While this could be a dangerous trend if more such incidents occurred, what
it really shows us is that the potential for market and price manipulation by
bad actors is ever present and may be the principle driver of a record setting
stock market even during a time of high unemployment and reduced economic
activity in the past year.
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