In the past couple weeks, established Wall Street hedge funds have been hemorrhaging large amounts of money as a result of having massively over shorted certain stocks like Game Stop. The reason: the subreddit board wallstreetbets networked a lot of day traders to invest in Game Stop (many using the Robinhood trading app) and not only bought up all the available Game Stop shares, but continued to hold them as the price rose dramatically, far past the point anyone might normally cash out.
As the price of the Game Stop shares continued to rise, it went far past the price points where the hedge funds had borrowed those shares. The stubborn refusal of the day traders to sell drove the price from a low of $17.25 January 4 to nearly $350 in the space of about three weeks, a massive over-valuation of a failing company. As a result, a lot of day traders were suddenly worth millions and the hedge funds were on the hook for billions of dollars.
Jeffery Martin at Newsweek explained what happened: “The activity of Robinhood investors was seen as an interruption of the practice of short selling, used by hedge funds to make money for their investors. Short selling happens when an investor borrows shares of a company stock that is expected to decrease in value. The investor then sells that stock. If the stock price falls, the investor repurchases those shares for a lower amount. With the profits, the investor can repay the original lender and keep the remaining money. On Thurs-day, Robinhood announced it would block the purchases of some stocks in response to “market volatility.” Some lawmakers condemned Robinhood’s business decision for not allowing regular investors to purchase stock as they saw fit.”
~ Jeffery Martin writing for Newsweek, 1/28/2021
Naturally, all of this volatility has attracted the attention of politicians and regulatory agencies, to the point where Alejandria Ocasio-Cortez and Ted Cruz have both expressed the same concern over Robinhood’s actions to block purchases. And as the battle between the day traders and the hedge funds continues, there is always the potential for fallout effects on the rest of the market.
“GameStop mania is putting downward pressure on the entire stock market right now: As hedge funds see their shorts backfire en masse, they’ve started selling off shares of companies with strong fundamentals, just to cover their losses, a move that drags down the value of the market as a whole, and with it, many ordinary Americans’ 401(k)s and trade unions’ pension funds.” ~ Eric Levitz for Intelligencer in the New Yorker, 1/27/2021
All of this begs the obvious question – where does it end? And, what will be done in response?
Reasonable, responsible regulation has never been a favorite topic in America – we want our freedoms, and when we get a taste of real power and privilege, we are loathe to do anything that removes our ability to maintain what we have. The game is played by the haves, the game is often rigged in favor of the haves, and the haves play games to keep what they have.
But now – the game has been exploited by the have-nots. And the haves are NOT happy. Not when their vast financial resources are seriously threatened – the hedge funds are exposed for literally tens of billions of dollars right now, and the rules require that they pay out what they owe. And yet, they are responsible for setting themselves up for this failure, by creating ways to make money off of literally nothing of value, except their promise to make good on their bets.
Should we feel at all sorry for hedge funds that borrowed 138% of available Game Stop stock?
Should we feel at all sorry for people that participated in this risky business and are now losing their investments?
Those involved in the hedge funds chose to play a risky game, and now, they have been caught out by the rules of the game. What lesson will they learn? What lesson will our nation learn?
I’m no expert on any of this – I’ve gotten some basic information from a few people I know that work in the financial sector, as well as from keeping up with news and analysis across the web. What do you think about all of this? What are the potential effects that will come about as a result of this exploitation of the market’s rules? Here’s what I think: