Strap in, kiddies, this is one wild ride.
On most days, I avoid business news. It’s usually dry stuff and I could never really wrap my head around all that talk of indices, portfolios, bulls and bears (oh my!).
But now I’m wishing I had paid more attention because the latest news has been some of the funniest stuff I’ve read in a while.
For those of you who haven’t been keeping up with the latest word on Wall Street, a bunch of billion-dollar hedge funds are losing money hand over fist… all thanks to trolls on Reddit.
Here’s the short version: those hedge-funds tried to short-sell the US-based videogame retailer GameStop but users of Reddit board r/WallStreetBets were having none of it and together they’ve helped push GameStop’s stock into the stratosphere.
To fully understand just what the heck’s going on, we’ll need to take a few steps back first.
What is short selling?
Put simply, short selling is when investors bet on a company’s stock losing value in order to make a profit.
They borrow stock from a vendor and sell it off at it’s higher price and, when it goes down, buy it back and return it to the vendor, keeping the difference.
Here’s a real life example from TLDR News: let’s imagine I think apples are going to go down in value in the near future. I then borrow an apple from a vendor for R1 and sell it to someone else.
When the price of apples drops to 50c, I then buy the apple back and return it to the vendor I borrowed it from, thus making a profit of 50c.
Again this is a gross simplification of the process but you get the idea.
Now you may be thinking that encouraging businesses to fail in order to make a quick buck sounds a bit unethical… and you’re right, it is.
There’s a reason another term for people who engage in this sort of behaviour is “vulture capitalists”.
One of the most notorious examples in recent history was the short selling of mortgage securities by people like Michael Burry in the lead up to the Great Recession in 2008, allowing them to make out like bandits as the global economy imploded.
Funnily enough, Burry has denounced the GameStop rally as “dangerous”, apparently without a shred of irony.
Of course, the process isn’t without risk since the stock price might actually rise, in which case the investors would then owe money to whomever they borrowed stock from. This will become relevant soon.
There are three groups we need to focus on here. The first is, obviously, GameStop.
Founded in 1984 (then known as Babbage’s), the US-based GameStop is a brick-and-mortar videogame retailer that, unsurprisingly, has been struggling lately thanks to the Covid-19 pandemic. With everyone stuck indoors, physical videogame sales have sharply declined in favour of online shopping.
It’s not a perfect company by any means but it has played a big role in the development of videogame culture in the US and for that reason has a solid fanbase.
Next in line is the various hedge funds who were attempting to short sell the company, the most notable of which is Melvin Capital. I don’t have space to get into all the details but to put it simply once again, a hedge fund is a company that manages investment portfolios for its customers.
The goal of any successful hedge fund is to maximise profit and, as we’ll see soon, this can lead them to making some really bad decisions.
Finally, we get to r/WallStreetBets (WSB), the mad geniuses behind this mess.
Reddit, if you didn’t know, is an anonymous messaging site that hosts many different discussion boards on a vast array of topics. As the name suggests, WSB is focused mainly on stock market speculation.
How serious the board takes itself seems to depend on the time of day but sometimes, such as the topic at hand, it can produce some truly spectacular results.
Alright so the stage is set, the actors have taken position, and now we ask the all-important question:
Just what the heck is going on?
As I mentioned earlier, GameStop has been struggling to adapt to the increasing popularity of online shopping and was certainly not helped by Covid-19 forcing everyone indoors.
A bunch of hedge funds saw this and decided that if GameStop is going to burn, they might as well chuck some gasoline on that bad boy and roast marshmallows.
They started shorting the stock hard in the hopes of driving the price down even further, possibly bankrupting the entire company.
By the way, their actions would have put nearly 15,000 people out of work in the middle of a pandemic and seeing as the US still hasn’t figured out that basic social safety nets are actually a good thing, this would have easily destroyed a lot of lives.
Thankfully their plans failed once the users of WSB caught on. Just how planned the next step was is up for debate but either way, what happened was a bunch of WSB users decided to simultaneously buy up GameStop stock in order to drive the prices up.
And it worked. Hoo boy did it work.
GameStop went from US18 a share just a few weeks ago to nearly US$450 by Thursday January 28.
While this certainly made the fine people at WSB a lot of money, it’s been devastating to the hedge funds.
Speaking of which…
If you're unclear abt the GameStop fiasco, Redditors are boosting the price of a publicly traded outfit in order to kill hedge funds trying to make a buck off GS's death
Once the short period is up, the funds must take the stock back at an inflated price. Like eating a grenade. https://t.co/gc1laOmHom
— Brother Q. (ɔpɛ asem) (@andraydomise) January 26, 2021
At the time of writing, it’s unclear just how long this saga will continue. What is clear is that this has hit the usually aloof Wall St gamblers real hard.
Losses by the hedge funds involved are estimated to be in the billions, with Melvin Capital having to be bailed out by fellow hedge funds Citadel and Point72 Asset Management to the tune of U$2.7 billion because of just how badly they screwed up.
It got so bad that Nasdaq CEO Adena Friedman suggested halting all trading in response.
Some trading apps have removed GameStop from their listings and even the US government is getting involved, with White House press secretary Jen Psaki saying “Our economic team, including Secretary [Janet] Yellen and others, are monitoring the situation.”
There are now calls from some for new regulations to be introduced but the biggest question we should be asking, I think isn’t how to stop this from happening again (especially since that would be virtually impossible).
Rather, perhaps we should be asking ourselves whether it’s really that good of an idea to give so much importance to a system that a bunch of bored forum-users can completely overturn just for the hell of it.
EDIT: It gets better