When the Dow drops by over two percent in one day, in this case 633.87 points, the cause is usually political. Last Wednesday, however, the reason came from a group of people who thought they were ganging up on hedge fund investors. The situation started last December when big investors did their usual “short selling,” betting companies will lose the value of their stock. An investor tells the broker to borrow the stocks and sell them at the current price, hoping the price will drop. After the company’s loss, the investor rebuys an equal number of stocks at the lower price, returns the borrowed stocks, and pockets the different in price as profit. The short seller only gets into financial trouble if the stock price goes up.
On Reddit, however, a large group of small investors tried to show big investors they weren’t in control. They used a free app allowing purchase of small amounts of stock, Robinhood, to purchase shares of GameStop, causing the stock prices to skyrocket. GameStop, a retailer with 5,000 stores selling video games, struggled even before the coronavirus increased online competition. Wall Street, convinced the company was due for bankruptcy, bought its outstanding stock “short.” In retaliation, Redditors planned a “short squeeze” to buy all the stocks at once, driving up the price. As the shorts got worried, they bought back the stock on its way up and drove the price up. Others decided to short the stock. Overvalued at $40, the stock was exorbitantly priced at $300 and so forth. Melvin Capital competitors had to bail out the hedge fund, which had a $3.75 billion loss.
Although their losses sound like retribution, many ordinary day traders also got in financial trouble while some financial firms benefited if they actually owned stock early on. Asset manager Blackrock, with 13 percent of GameStop, gained about $2.4 billion from $173.6 million worth of stocks in about a month. Norway’s government also owned 2.6 percent of GameStop.
The problem for Redditors is when to sell. The price won’t stay at today’s price of $325 forever, and people may lose bigtime. And while they think they are scheming against Wall Street, they are doing exactly the same thing as hedge fund investors. The stock market has nothing to do with investing in companies—just in stripping its resources.
Vice has a detailed description of the GameStop event.
The GameStop saga didn’t end with people purchasing the stocks. By Thursday, Robinhood decided to stop selling stocks from both the video game retailer and other companies caught up in the decision. It also raised margin requirements for some of the securities, forcing users to front more of their own money for purchases and benefiting investors with more ready cash. TD Ameritrade and Charles Schwab did the same thing. Short-sellers bought shares to hedge their positions, sending the stock market up by over 300 by the end of Thursday.
A Robinhood customer filed a class-action lawsuit against the app with almost 31,000 users for banning sales of GameStop shares, claiming the action rigged the market against its customers and benefited those who weren’t—especially the huge hedge fund investors.
After a backlash, Robinhood announced “limited buys” of GameStop and other drastically shorted stocks, raising $1 billion overnight to comply with federally mandated capital requirements. GameStop shares increased almost 65 percent Friday, up $308 since the beginning of the year from $17 per share, going as high during the day as $414. Yet pessimism about economic problems and anxiety about the trade volatility dropped the Dow another 621 points, another two percent down. The week’s loss was 1,000 points.
Before Robinhood reinstated trading, the amateur traders pushed negative reviews about the app, leading to Google’s one-star rating early Friday morning based on 275,000 reviews. By noon, however, the rating went up to four stars after 100,000 reviews mysteriously disappeared, supposedly deleted by Google.
The melodrama continues on Monday. After saying on Friday that he was not pressured to restrict the sales of stock, the head of Robinhood is again restricting these sales, narrowing a list of 50, however to only eight: GameStop, AMC Entertainment, BlackBerry, Koss, Express, Nokia, Genius Brands International and Naked Brand Group. For example, users can buy only one share and up to five options contracts. They are permitted ten each of AMC stock. Robinhood said the limits were subject to changes throughout the day.
Last week, the central Wall Street clearinghouse required a ten-fold increase in the firm’s deposit requirements last week. The clearinghouse also required an increase in Robinhood’s margin, the funds in a client’s account when they borrow to buy a security. Huge collapses in share prices, highly possible with the risks taken in buying GameStop and other heavily shorted securities, leave Robinhood on the hook. Margin shares could have placed further strain on Robinhood’s balance sheet, potentially leaving the broker on the hook in the event of a massive collapse in GameStop’s share price.
Jaime Rogozinski, possibly the founder of the Reddit community, called the insanity of GameStop’s shift in share prices “a train wreck happening in real time.” Keith Gill, the trader kicking off the scheme called r/WallStreetBets, said “he didn’t expect this.” Jim Cramer, Wall Street commentator on CNBC, referred to it as “insane.” Video game industry analyst Michael Pachters said it was a Ponzi scheme, a fraud appearing to make money only when propped up by funding from new investors. Critics described Robinhood as a dangerous “gamified” stock trading.
While the news may appear to affect only those involved, it shows “how social media can upend everyday life,” according to tech writer Ian Sherr. He explained:
“Twitter has changed the worlds of news and politics. YouTube and Instagram have transformed the fashion, beauty and entertainment industries. Now Reddit is taking on Wall Street… And TikTokers banded together in attempts to confuse President Donald Trump’s reelection campaign.”
Other stocks targeted by Reddit communities include the once-popular Blackberry and the struggling movie chain AMC. Nasdaq, the stock market index focusing on tech companies, threatened to stop trading on stocks manipulated by social media.
The gambling of Redditors and hedge fund investors exacerbates the problem of growing inequality in the U.S. and the economic problems of the vast majority of its population. Billionaires’ assets have gone up 38.6 percent in less than a year. The $1.1 trillion they acquired is equivalent to over $3,400 for every person in the United States. And billionaires make this money because they own most of corporate stock.
People who try to cover for the huge inequality claim these wealthy people have fortunes because of their exceptional talents. For example, Elon Musk, Testa’s CEO, was worth $24.6 billion last March; last week he had $179.2 billion. Yet his increase came from business-supported government policies and a plutocracy in which very few accumulate most of a nation’s assets. In addition to DDT’s gift to the wealthy of huge tax cuts, the Feds contributed to their riches with low interest rate policies to “grow” the economy. Last year, the Dow Jones, Nasdaq, and S&P 500 hit record highs. New financial instruments help rich people get more money; i.e., special acquisition companies (SPACs) to buy shares in companies wanting to cash out or expand. The result is greater demand for shares and higher windfalls for the top executives who had done nothing special.
Even the misnamed Robinhood is making big bucks from Redditors’ “games” from “third party” financial companies paying Robinhood for each client trade. One of them, Citadel Securities, belongs to hedge fund billionaire Ken Griffin, who bailed out Melvin Capital by taking a big ownership share in the hedge fund loser. Other Wall Street players—Goldman Sachs, JPMorgan Chase, and other big banks—make money off Redditors with its “dark pools,” hidden exchanges serving the big institutional investors without the need to specifically or timely report their trading. The relationship between Robinhood and its investment firms may face an investigation.
The whole Reddit/Wall Street/GameStop debacle is destined to end badly. Bored and frustrated by low interest rates, participants treat investing like entertainment, behaving like a mob at a sports event. The winner will be Robinhood and other zero-cost brokerages who gamble on the ignorant traders. A few investors will sell before an inevitable crash, but more will lose everything from greed. Last summer, a 20-year-old student killed himself because he thought he had lost $730,000 on an option. In fact, he was $16,000 in the red.
Financial markets are meant to move capital from savers to firms needing capital. The sideshow of GameStop does nothing to benefit the company while destroying faith in the markets’ functions. Hopefully, the COVID-19 vaccine will allow Redditors to find other amusement. Meanwhile, GameStop is the one without benefits: the company plans to close almost ten percent of their stores this year.