Can't Stonk Won't Stonk Game Stonk

Via r/wallstreetbets

Disclaimer: This is a guest post from a friend that works in finance. The views and opinions expressed in this post are of the author and do not reflect the official policy or position of any other agency, organization, employer, or company.

The most miraculous aspect of last week’s wild swings in Gamestop share price, is not the fact that an orchestrated short squeeze leading to a massive asset bubble captivated the market. Indeed, high drama short squeezes and bubbles have been part of the fabric of the free market since it began. The most amazing part of the story are the conditions and narrative that resulted in a perfect storm, leading thousands (millions?) of small-time investors to believe that by participating in a classic pump-and-dump they were leading the charge of righteousness and justice.

First, I should clarify, as a supporter of the free market, I believe that the “retards” and “autists” have every right to trade, whatever their reasons. However, the righteous “sticking it to the man” cause behind which they have rallied requires a level of mental gymnastics that suggests that the goal is not worthy of risk that they have taken.

Let’s start with the conditions, which are primarily social in nature. First, the advent of Robinhood and its classic flick-through-the-fine-print-to-get-to-the-pretty-graphics Silicon Valley interface has made access to investing in individual stocks and options easier than ever for the Millenial and Gen Z set. Second, the boredom of the pandemic has led to a rise in retail trading, reaching the highest levels ever in the US (to almost 25% of trading volume in 2020) as well as many other countries. Third, the economy has bifurcated materially during the pandemic, as white-collar desk workers continued their jobs uninterrupted while their stock portfolios expanded, but service workers impacted by the lockdown were sent home, sending unemployment in the US to a peak of 13%. This has led to even more enthusiasm for the populist narratives that have dominated the political landscape across the globe in the last few years. Finally, misinformation continues to accelerate in social media.

The populist motivation is there. The free-commission trading tools are there. The time to devote to and the platform for developing the viral memes is there. Now, we just need a story to put it all together.

So, what is it? Buying GameStop stock will bankrupt hedge funds and expose a system that reserves special treatment for the boomer elite at the expense of the common Gen Z / Millenial. It sounds like a great reason to fight "the man" with your savings right? And it's not completely divorced from the truth: it's just truth that has been sprinkled with enough fairy dust to turn a rather ambiguous set of observations into a cause worth crusade-like devotion. So, let's go step-by-step through the assumptions one has to make to become a true believer.

First, you have to believe that hedge funds just help the rich get richer. This is probably the truest part of the story. While it is true that many hedge funds invest money for good organiztions like public pensions and endowments and also that most hedge funds are not actually successful, many do invest money for the already rich, like sovereign wealth funds, and family offices, and pay their managers well into the top .01% of incomes.

Second, you have to believe that these excessive hedge fund returns are propped up by the government. Again, there is a grain of truth here--many hedge funds, like the general public, were able to salvage their businesses due to the government bailout of the banks that held their accounts during the 2008 financial crisis. But, it's also true, that the first organizations to discover the overlevering of the mortgage market were hedge funds, and that hedge funds did not and have not directly received bailouts from the government. . .just as Melvin Capital, the current target of redditors' ire, did not receive a "bailout" last week. Yes, Melvin inked an emergency recapitalization from their investors after losses on their short position in GameStop, but it was no different from any tech start-up receiving another round of funding from their investors.

Next, I think you have to believe that all of the most evil hedge funds were short GameStop. Yes, the redditors did their homework, GameStop is one of the most shorted stocks at the moment, with over 140% of shares lent. But buying volume shows that many large asset managers were also long, and/or took profits on the stock in the last week. It's likely that for every Melvin capital, there is another hedge fund quietly taking advantage of redditors' enthusiasm.

Another helpful piece of evidence to support the crusade, is the woefully-timed and poorly explained halt on buying from Robinhood on Thursday, which is certainly consistent with the idea that the evil financial system shut down retail traders in collusion with "big finance." Later, Robinhood explained that the increase in volume in trading led to them being unable to meet margin requirements, and they too had to go to investors for a fresh injection of $1bn to meet those minimums. Turns out, margins are legally required to ensure investor safety, consumer protection if you will. Many of the most strict of those rules were adopted after the 2008 financial crisis, designed to prevent financial institutions from the overleverage that led to that kind of systemic failure.

Finally, you have to believe that hedge funds behave like a single coordinated entity. Of course, some, who have been savvy enough to avoid the SEC, probably are. But there are thousands of hedge funds, diverse in both strategy and size. Very few are very large, and there are a great many who will come and go without ever making it into a newspaper, which they do about as frequently as tech start-ups in dorm rooms.

How does it all end? Likely how any bubble does. The WSB mantra of "hold!" is not enough to keep the price going up. More and more of the righteous need to be recruited to continue the outsized returns. Every new redditor who joins the cause is putting money directly into the bank account of Roaring Kitty, and the other early participants in the trade (which includes many hedge funds!) As soon as some realize this and begin to take profits or shore their losses, the gig is up. Not to mention, there is a shorter of last resort, who is both incentivized to and can flood the market with infinite shares of GameStop. . .GameStop, the actual company, who can issue new shares, and why wouldn't they considering the value they can apparently get for them?

So, what does the story look like now? Invest my hard-earned savings to potentially shutter some hedge funds, many of which are just a couple of guys in their garage, while also helping others get even richer, to expose a part of a system that was designed to protect my assets, all to eventually line the pockets of the movement's so-called leaders. It doesn't sound so righteous anymore does it? The financial system is by no means perfectly just, but in this case all the safeguards are working as expected. It's the social commentary this episode represents that I find even more interesting. Even though I wouldn't put in my own savings, I still support the movement-- the memes have been awesome.