If there is anything that the ongoing pandemic, the unusually fraught transfer of power, a generational economic crisis, and a refreshed reckoning with our nation’s racial past have laid bare, it is an intense anger among the American people with their public institutions. It is only with that anger in mind that we can contextualize last week’s happenings on Wall Street, where an impassioned uprising of retail investors called hedge funds’ bluffs en masse and sent the stock prices of companies like GameStop, AMC, Nokia, and Blackberry skyrocketing — costing institutional short sellers billions of dollars in the process. That struggle, and the backlash it has caused from brokers like Robinhood, throws light on just how few people hold the keys to the financial system that affects so many Americans, even in a time when financial tools are at everyone’s fingertips.
If, like many Americans, you found it bizarre that the strip-mall retailer you used to buy Xbox games from became the hottest financial asset in the country, there’s quite a bit to explain. Shorting, as you may be aware, refers to the process of betting against a stock’s price — but the actual mechanics of how that works is important. To short a stock, you borrow one from your broker, sell it immediately, wait for the price to drop, then buy the stock off the market at the reduced price, and return that to your broker. You earned the price of the stock at the beginning of the period, spent the price at the end, and you net the difference.
There are three key pieces to note here. First, since a stock can theoretically appreciate in value infinitely, but only lose a finite amount, the potential loss of a short position is infinite. Second, short-sellers don’t actually own anything during the process of the short, meaning that it is theoretically possible for short sellers to short a greater quantity of stock than actually exists on the market. Third, to close out a short position, you need to buy a stock off the market. If it’s hard to acquire one, and the price increases… well, you may be starting to see what went wrong.
Enter /r/WallStreetBets, or WSB. Often described as “what would happen if you gave 4Chan a Bloomberg terminal,” the subreddit has long been infamous for its worship of extremely high-risk trading strategies; losing hundreds of thousands of dollars gets you just as much respect as earning the same sum would. But let it not be said that they don’t do their research. Users on WSB discovered early this month, using publicly available information, that short sellers, mostly hedge funds, had accumulated short positions on GameStop ($GME) of around 140 percent of the total stock volume. To close those short positions, that stock would need to be bought back, no matter its price. To capitalize on this, and to punish what many saw as a perversion of market principles against an American company many are fond of, WSB users began what is known as the short squeeze — buying $GME at ever-higher prices and forcing short sellers to either close their positions at massive losses or risk those aforementioned infinite losses.
News of the squeeze spread quickly. Fueled by the anti-establishment glee of sticking it to the man, as well as a fear of missing out on multiplying profits several times over, the price of $GME, which had been $4 last summer and $17 in early January, skyrocketed past $350 on Jan. 27 and hit $469 on Jan. 28. But on the 28th, Robinhood, the trading app that became popular offering fractional shares to everyday Americans, disallowed users from buying any shares of GameStop, as well as a few other heavily shorted stocks for which the same squeeze was underway. This action, along with similar ones by other brokerages, sent $GME’s price back down to $132, although anger at this decision fueled a rally back up to the mid-$300 range on Friday.
The decision of Robinhood, among other brokerages, to shut down trading for some stocks has kicked off a battle for control in the financial markets that spans far more than just WallStreetBets. Robinhood, as its name suggests, has been hailed in recent years for bringing trading to the masses, but its decision Thursday to halt trading on a legal, democratically initiated stock movement shows just how much gatekeeping remains in the financial sphere. (It should be noted that the company makes a significant chunk of its income selling users’ trading activity to high-frequency trading firms, a fact that the SEC fined the company $65 million for failing to disclose.) As much as brokers have put trading tools into the hands of everyday Americans over the last decade, there still exists a massive gap between the investment firms that run Wall Street and the retail investors.
This gap exists not only in terms of prestige but also in consequences. As just about everyone on both sides of the aisle has been saying this week, it seems that Wall Street has been playing by a different set of rules than the rest of us, and when the rules that have allowed them to make bad bets for decades finally turned on them, they couldn’t take the heat. The WSB short squeeze is exactly the sort of action that hedge funds have been making for years, because, hey, it’s just business. So it’s hard not to find the reactions of many in finance comical when they come from the overseers of a regime that has presided over a massive movement of wealth from the lower and middle classes to the top 0.1 percent. Sure, the organization of retail investors from WallStreetBets is an unprecedented event, but it’s hard to make the case that a free, public forum sharing publicly available stock information is a market aberration deserving of censure.
WallStreetBets’ gamble on GameStop is more than just an opportunity to make a quick buck, however, although that’s certainly a big part of it. A quick read of the subreddit shows that many of the users (the most active ones, anyway) are largely motivated by disgust at the practices of hedge funds and brokerages, and its posts are rife with populist messaging about taking back control of the stock market. There’s certainly something admirable about it, although one might be worried for newer investors buying GameStop stock without being prepared for the level of risk WSB usually traffics in; nonetheless, it’s clear at a glance that there is a massive pool of people who have been waiting for an opportunity to strike back at the finance industry, against a system that feels rigged to work for just a few while the rest are left out.
But you’ve heard this story before. Just as in the banking crisis a decade ago, a glimpse behind the curtain reveals a system of moral hazards and failing incentives. Between 2007 and 2009, the CEOs of Citigroup, Merrill Lynch, and Bank of America were given — given! — a combined $272 million when leaving their firms. All three companies received federal assistance. Lehman Brothers, upon its bankruptcy, had a debt-to-capital ratio of 30.7 to 1. While the Dodd-Frank Act and the Volcker Rule have improved oversight and reduced investment leverage, it has already begun frittering away under GOP leadership. While we’ve seen leaders from Alexandria Ocasio-Cortez to Ted Cruz call for investigation and oversight over Robinhood’s actions last week, if those calls don’t translate to constant vigilance and a commitment to making things different this time, we’ll be in this situation all over again.
There might be a glimmer of hope, however. As the short squeeze devastated some hedge funds and frightened the living daylights out of others, Morgan Stanley reported that many funds are beginning to retract their shorts, reduce their debt-to-capital ratios, and cut down on trading risk. If the financial crisis and regulation couldn’t keep the funds from taking on massive risk, it would be almost a miracle if a subreddit could. While the GameStop short squeeze is bound to end eventually, retail investors have sent a lasting message to institutional finance — that in an age of information, everyone can play at their game.