Over the past few weeks, you’ve probably seen stories about GameStop’s stock surging, and you may be a bit confused. In recent years, GameStop has grappled with substantial executive turnover, an increase in digital game sales, and COVID. Many have been predicting their downfall for years, so why the sudden upturn? The company added new board members early in January, and optimism could account for the initial increase. But by mid-month, the company’s stock price was skyrocketing far beyond a normal recovery. Something big was happening behind the scenes on an app called Robinhood. Something much bigger than GameStop alone. Something so bizarre it would eventually even have AOC and Ted Cruz agree on something… although certainly not together.
Shorting GameStop stock
Recently, hedge funds like Melvin Capital invested massive amounts of money into shorting GameStop’s stock. This essentially means that the hedge fund borrows shares from lenders, then sells them at their current price. They do this because they are gambling that the value of the company (and thus the share) is going to decrease soon. And it’s a pretty good gamble because the act of selling off a large number of shares itself will often drive the price down. It’s a way to bet against a company’s success while putting a thumb on the scale. Later, they can buy back the share at a much lower price. They return the share to its rightful owner and pocket the additional profit.
For example, a share of GameStop stock was valued at $15 on October 23 of last year. A week later on October 30, it was worth just $10.47. So a savvy hedge fund manager could have borrowed and sold shares at $15, then bought them back up at $10.47. They’d get to pocket most of the additional $4.53 generated by each share, minus an interest charge for borrowing the shares. And when you’re borrowing millions of shares at a time, that adds up fast.
But it’s a gamble. You’re counting on (and trying to bring about) a decrease in GameStop’s stock price. If something happens to increase the company’s value, those shares you need to buy back become more expensive, and you can end up losing money. A company’s stock price goes up when there’s a demand for it. In theory, demand is driven by real-life services or products generating real-life cash…but that’s often not how it works. Stock is influenced by belief. Stock is influenced by hype. Shares can rise and fall in value based on social media buzz that has little to do with the bottom line. In the end, a company’s shares are worth whatever people are willing to pay for them. If the price keeps going up and people keep buying them anyway… the price keeps going up.
Now an average person doesn’t have the resources to influence the price of a share in the way that a multi-billion dollar hedge fund does. But tens of thousands of average people working together do. And that’s where WallStreetBets comes in. This online community describes itself as “if 4chan found a Bloomberg terminal,” and the fact that “GameStonks” has been trending all over should give you a pretty good idea why.
Throughout January, wave upon wave of WSB members invested at higher and higher amounts. As the popularity of buying GameStop stock grew exponentially, the price of a share rose from $17.25 on January 4 to $31.40 nine days later. But that was just the beginning. By January 25, a GameStop share was worth $76.79. Then it nearly doubled again to $147.98 in one day.
If you borrowed and sold shares at $17.25 just 3 weeks ago, it will now cost you 8.5 times as much to buy those shares back now and cover your debt. If you borrowed millions of shares… that would be a catastrophic loss. You gambled and lost. You can either bite the bullet… or just keep gambling by waiting it out and praying that the price goes down soon.
But that’s not what happened. On January 27, GameStop’s stock price more than doubled again, soaring to an unthinkable $347.51 per share. Melvin Capital finally gave up and closed out its position. The exact amount they lost is unknown, but it’s in the billions. Although there were reports that the hedge fund would file for bankruptcy, founder Gabe Plotkin says this is incorrect. CNBC reports that “Citadel and Point72 have infused close to $3 billion” to help the company bounce back.
A bigger picture
But this isn’t just about Melvin Capital. And it’s not really about GameStop either. GameStop was one of the most shorted stocks in the world. According to estimates by S3 Partners, short-sellers lost a combined $23.6 billion as of January 27. That includes $14.3 billion in losses in just one day. And once that was accomplished, WallStreetBets turned its gaze on other popular shorts, including Bed, Bath, and Beyond, AMC Theatres, and other struggling companies. Anywhere you can find wealthy hedge funds betting hard that a company will fail, you can find an army of small-time investors pushing back in the opposite direction.
It’s not that thousands of people specifically care about “saving” GameStop, nor do they necessarily believe the company is actually a worthwhile investment. Although there are certainly people who have profited quite handsomely off this entire bizarre affair in the short term. GameStop is the setting, not the plot. It’s a singular battleground in a much larger conflict that has become inevitable in the internet age.
The rapid evolution of modern technology has made the stock market more accessible than ever. Millions of regular people can download apps and trade for themselves, sidestepping traditional channels. The internet has provided those people with far more data about any given company, product, or service than we ever could have imagined just a few decades ago. And with that knowledge, more people are becoming aware of the various ways in which those at the top keep things working in their favor.
That knowledge put in the hands of a fired-up Reddit crowd became a way to flip the system. If they’re betting a company’s price will go down, WSB will guarantee it goes up. The results speak for themselves. Hedge fund managers were dealt massive financial blows. It’s fitting that most of the trading was done on Robinhood, an app named after the legendary hero who stole from the rich and gave to the poor. The rich never like that. Outraged by what they see as market interference, they want someone to… interfere in the market and put an end to this. But at this time there’s no evidence of anything illegal happening. There’s no “stealing” to punish. Which really should spark questions about how the market functions.
If a handful of people with tremendous wealth coordinate to drive the value of a company down while betting on its failure, that’s just how the market works. If their actions lead to mass layoffs or company closures, that’s the tough reality of the free market. That’s how it’s always been. Should it be any different when those with little wealth coordinate in greater numbers? And perhaps more importantly, if the stock market can be so utterly manipulated by either party, is it really a stable metric by which to judge the health of an economy? Why can Reddit and hedge funds managers turn a company’s stock price into a roller coaster with virtually no input from the company itself?
There are also still many questions about who all reaped the benefits of these extreme market fluctuations. The narrative of the poor getting theirs at the expense of the rich is enticing, but not all major investors were shorting GameStop. Wealthy investors are just as capable (more so, really) of capitalizing on someone else’s short. Reuters estimates that BlackRock, the world’s largest asset manager, likely gained billions of dollars. And Elon Musk, one of the richest people in the world, famously promoted the WallStreetBets Reddit with a “GameStonks” tweet. And remember how Citadel swooped in to save Melvin Capital? They also happen to have a lucrative partnership with Robinhood. It may be quite some time before we unravel the chaos and comprehend the full impact of what has occurred over the past few weeks.
Robinhood and the government
At this time, there hasn’t been any government intervention, but the news has reached the highest levels. White House press secretary Jen Psaki revealed that United States Treasury Secretary Janet Yellen and others in the Biden administration are monitoring the situation. Meanwhile, the SEC put out the following statement:
We are aware of and actively monitoring the on-going market volatility in the options and equities markets and, consistent with our mission to protect investors and maintain fair, orderly, and efficient markets, we are working with our fellow regulators to assess the situation and review the activities of the regulated entities, financial intermediaries, and other market participants.
While the government hasn’t stepped in to make a ruling, other intermediate parties have. Robinhood, now concerned about the consequences of living up to its namesake, has pulled the plug on GameStop purchases. Ditto that for numerous other companies that are currently being shorted. The investment app sent out the following statement to its users today:
In light of recent volatility, we are restricting transactions for certain securities to position closing only, including $AMC, $BB, $BBBY, $EXPR, $GME, $KOSS, $NAKD and $NOK.
Other apps are following suit, and GameStop’s stock is crashing back down as a result. As I’m writing this, share prices have plunged over 30% on the day. A share is still worth far more than just a few weeks ago, but it’s unclear what lies ahead. “DO NOT SELL” is currently trending as GameStop investors encourage each other to hold firm and wait out the setback.
AOC and Ted Cruz
In the meantime, Robinhood’s decision is so controversial that it’s drawing criticism and scrutiny across the political landscape. Democrat Representative Alexandria Ocasio-Cortez (better known as AOC) has demanded an explanation for the decision. Cortez criticizes the fact that millions of average Americans are now locked out of their investments while hedge fund managers are free to operate as normal. She is calling for a hearing by the Financial Services Committee and plans to discuss the situation on a Twitch livestream later tonight. Republican Senator Ted Cruz, often a critic of Cortez’s positions, tweeted out his full agreement. Clearly, this is an issue that is attracting bipartisan support.
That said, do not expect the duo to investigate Robinhood together. Cruz is not one of the committee’s members as it is a House committee. AOC has also made it clear that, while she hopes for bipartisan support, she has no interest in partnering with Cruz specifically due to his behavior preceding and during the assault on the Capitol earlier this month. Whether or not other politicians step forward regarding either Robinhood or the larger market issues remains to be seen.