Streetwise Professor

January 28, 2021

Let the GameStop Games Begin!

Filed under: Economics,Exchanges,History,Politics,Regulation — cpirrong @ 9:33 am

Short sellers have been hate objects since the earliest days of the U.S. stock market–witness the checkered lives of the likes of Daniel Drew or Jacob Little. It is therefore no surprise that the travails of their latter day descendants–hedge funds like Melvin Capital–that have resulted from the huge runups in the prices of stocks like GameStop ($GME) have been the source of considerable schadenfreude. I would suggest, however, that this will end in tears not just for the hedgies, but for those who contributed to their massive losses.

Long story short (no pun intended).  Small investors pile in a stock (GME, and some others like Blackberry), driving up its price.  Hedge funds think the stock is overpriced, so they go short.  A group of small investors thinks that this is an opportunity to punish the short sellers (a lot of mutual disdain/hate here), so via the reddit group WallStreetBets they coordinate to buy more, driving up the price further.  This imposes big losses on the shorts, who buy to cover, driving up the price further, imposing more losses on the remaining shorts, driving them to cover, etc., etc. 

It brings to mind an old doggerel poem from the Chicago Board of Trade in the 19th century:

He who buys what isn’t his’n, Must buy it back or go to prison.

In the case of GameStop, the price action went hyperbolic:

That chart ends at yesterday’s close. Things have been even more crazy overnight, with the price hitting $500/share. There have been gyrations caused by the shutdown of the chatrooms and some retail platforms stopping trading in this and other heavily shorted stocks. But the fundamental dynamic in play now–shorts slitting their own throats in panicked buying to cover–means that attempts to constrain the long herd will not have a lasting impact.

The short interest that had to (and has to) be covered is huge–short interest in GME was 140 percent of outstanding shares–and a larger share of the float. (How can there be more shorts than shares? The same share can be borrowed and lent multiple times!) The effects of the short covering are seen not only in the price, but in the stratospheric cost of borrowing shares. Earlier this week it was about 30 percent–juice loan territory. Now it is at 100 percent.

In many respects, this is reminiscent of some of the more storied episodes in Wall Street history, or more recently the 2008 VW corner which punished shorts severely. But there is a major difference. In some of the earlier episodes (including major corners of shorts in railroad stocks in the 19th century, or battles between shorts and stock pools in the 1920s, or the VW case), there was a single dominant long squeezing the overextended shorts. Here, it seems that the driving force is a relatively large group of small longs, acting with a common purpose.

How will it end? Well, the stock is obviously overvalued, and driven by “technical factors” (as is sometimes said euphemistically). It will crash to earth. When? Well, when the shorts get out. Who will lose? Well, the shorts are likely a big portion of the purchasers at these nosebleed levels, so they will be the biggest losers. But there will be some latecomers and trend followers who will have followed the Pied Piper of rising price, and will lose in the inevitable crash.

Should we really care? There is some possibility that the disruption in GME and other heavily shorted stocks could have knock-on effects. Hedge funds suffering large losses may have to dump other positions, causing those prices to decline. (The events surrounding the Northern Pacific corner, for example, sparked the Panic of 1901.)

One fascinating aspect of this is how it demonstrates the deep populist discontent that is in abroad in the land. The hedge fund laments have been met with a barrage of scorn and ridicule, with a major theme being “you a$$h0les got bailed out in 2008 while the little guy got hammered–how you likin’ it now?” Completely understandable. Revenge of the nerds, as it were.

But, alas, I do not think the visceral satisfaction will last. Things like this inevitably result in litigation. The WallStreetBets lot are in for major lawsuits filed by the losing hedge funds, and perhaps others (e.g., investors who had sold call options).

Following the trend and herd trading is not manipulation–as long as the herd doesn’t explicitly coordinate with the intent to move the price to uneconomic levels. However, many on WallStreetBets expressed an intent to drive up the price in order to impose losses on their bêtes noires, and apparently coordinated their buying activity to achieve this result. Intent and cooperation make the manipulation. Note that the explicit communication and coordination could also transform this into a Section 1 Sherman Act claim–with the attendant triple damages.

Now the hedge funds will never collect even a fraction of their losses. But for them, the process will be the punishment inflicted on their foes. Pour encourager les autres.

The SEC is not committing to any action right now. It merely says it is “monitoring” the situation. The DOJ has also been silent.

However, they will be under tremendous pressure to act. Ultimately, the decision will be political–precisely because of the political nature of the populist resentment. The hedge funds and Wall Street generally will be howling for the government to file cases. But if the government does so, there will be widespread popular outrage that the government is taking the side of the Wall Street elite. Again.

This will be the first thing on Gary Gensler’s plate at the SEC. He is in a no win situation. (Breaks me all up.)

In sum, the events of the past days have been fascinating from both an economic and a political perspective. They represent a back-to-the-future moment of colossal battles between longs and shorts, but with a major twist: whereas the historical battles tended to be between colossi, this one pits an army of Davids against a few colossal hedge funds. This in turn gives rise to a political narrative, which again has historic echoes–the little guy vs. Financial Capital. It’s like the 19th century, all over again.

The battle will play out for some time. For a few days or weeks in the markets, and in the courts for years after that.

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24 Comments »

  1. Fascinating stuff (Captain).

    So Wall Street lobby their poodles in Congress to keep the Market unregulated…get their arses handed to them by a bunch of aggrieved millenials…& resort the their poodles in the Courts to make an example of said AM via lawsuits.

    I really don’t think they understand where this ends.

    Comment by djm — January 28, 2021 @ 10:11 am

  2. The longs here are playing classic cyberpunk: noting that the rules are written to favor politically-connected insiders, but finding weakness where the rules are *expensive to enforce*. Taking litigation against a distributed crowd like this would create a huge drain on SEC staff, while at the same time denigrating to the sense of self-importance that motivates the rank-and-file. Let’s hope any invocation of Sherman Anti-Trust against a distributed foe goes better than the Pullman Railroad Strike, eh?.

    Comment by M. Rad. — January 28, 2021 @ 10:49 am

  3. Is it possible for nerdy small longs to encrypt their identities, roadblocking a lawsuit?

    Comment by Pat Frank — January 28, 2021 @ 11:06 am

  4. @Pat Frank, one cannot encrypt one’s identity on stock exchanges; the buy orders are all there for government agents to see, with attendant KYC information. Similarly, Reddit can be served subpoenas for whatever personally identifying information they have on the authors of the posting, which, unless the poster had been very careful about opsec (throwaway email account on an encrypted service, masking IP address when logging in, etc), will reveal the posters’ identities.

    That said, with blockchain-based “initial coin offerings”, it *is* possible, with reasonable effort, to invest with cryptographically-guaranteed anonymity. Government regulators awoke to this fact sometime around 2017-2018, and have been in the grip of reactionary terror ever since. For example, the Abra project created a market for crypto-based “synthetic assets” (derivatives designed to track the price of the real asset, without anyone actually owning the asset), which allowed anyone (for example in the Philippines where regular folks have few investment options) to effectively buy, for example, Tesla stock (contrary to Our Blogging Professor’s likely recommendation). The SEC shut them down, despite Abra having a stated policy of not catering to US persons, geo-fencing US IP addresses, and offering to divest any particular transaction the US government named; the fact that US persons *could* invest (the government never showed evidence that anyone had actually done so) by using a VPN to spoof their IP was enough for them to claim jurisdiction to enforce US KYC law anywhere in the world. A similar story of extra-territorial jurisdiction holds for Bitmex.

    The “What Bitcoin Did” podcast on Abra, #WBD073, is a fascinating listen, BTW.

    Comment by M. Rad. — January 28, 2021 @ 11:50 am

  5. As usual, the lawyers will be the winners.

    Comment by Andrew Stanton — January 28, 2021 @ 1:12 pm

  6. Looks like the nerdy small longs will strike back with a class action lawsuit, Pat – at least those that are now blocked from buying further GME shares on Robinhood (they can only sell!)

    Comment by [email protected] — January 28, 2021 @ 1:46 pm

  7. @4 Oh, what tangled webs we weave, with moneyed plots ‘gainst those aggrieved.

    Comment by Pat Frank — January 28, 2021 @ 2:26 pm

  8. I’ve been watching the tape for GME a bit and have been fascinated by the number of 1, 2, and 5 share lots that I see (especially in the after-hours). I think the (slight) difference in this case is zero commissions, enabling the “little guy” to trade such small lots with fewer transaction costs.

    Comment by Highgamma — January 28, 2021 @ 3:20 pm

  9. It wouldn’t surprise me if there’s a hedge fund, or some big money (softbank?) that lit the fire under GME with the initial OTM short dated calls purchases, maybe some after-hours purchases of equity (when volume is light) and some targeted posts on WSB. This could be the battle of the titans, with one side using populist politics as a tool — getting retail flow to pile-on after they’re positioned and wanting to exist only helps. Plus, provides political protection too.

    Comment by Kevin J. Gates — January 28, 2021 @ 3:47 pm

  10. There may be a ‘no tears at bedtime’ solution. The company can print as many shares as it likes, and sell them to whomever it likes. It could arrange a private placement to the shorts, they hand over billions to the company, which in effect becomes a cashbox with a balance sheet that justifies the now much higher share price. And the Redditors clean up.

    But finding a sensible, win-win solution goes against the spirit of the age, which more favours people ripping each other’s faces off while calling each other nazis. So it probably won’t happen.

    What IS happening right now is a revolt against the rules being changed mid-game to favour the well-connected hedgies. London to a brick GG won’t be interested in evening THAT playing field: retail investors are the shock absorbers of the market, after all.

    Either way, the Trading Places-style reversal of fortune is fascinating to watch. Real popcorn-munching stuff.

    As for litigation, can you imagine the indictments? ‘The People versus u/Retard69, u/PotatoButtFace and u/Throwaway82649’.

    Comment by Ex-Global Super-Regulator on Lunch Break — January 29, 2021 @ 12:11 am

  11. Professor, when is the market going to bring Tesla and Elon back to reality?

    Comment by aaa — January 29, 2021 @ 12:26 am

  12. Expect our self-proclaimed betters to use this for more regulation. More ordinary-Joe-kicking. Making this club more exclusive, so eponymous Joe will never have a chance of becoming “a small investor”. Have you heard Warren on the subject?

    Comment by Tatyana — January 29, 2021 @ 6:50 am

  13. Well Tatyana, in this case more regulation would be welcome. No naked short selling, more transparency on payment for order flow business models, less arbitrary decision making by brokers!

    Comment by [email protected] — January 29, 2021 @ 7:16 am

  14. poor deluded libtard:
    more regulation is never welcome.
    let the markets be free – and fall and rise as directed by [human] nature.

    Comment by Tatyana — January 29, 2021 @ 8:22 am

  15. The whole point was the markets weren’t free when Robinhood is able to restrict people from buying GME shares. That needs to be investigated and security laws (=regulation) needs to reflect that. That’s my point.

    Your ad-hominem attacks are puerile. I am on your side here, but you don’t seem to realize it.

    Comment by [email protected] — January 29, 2021 @ 11:21 am

  16. “…Your ad-hominem attacks…”

    yawn.

    go write whiny letters to the UN.

    Comment by Tatyana — January 29, 2021 @ 12:13 pm

  17. Re the squeeze – I am so happy!!! This sort of deal has gone on for years; back in either the late eighties there was a face off between gorillas over a company called tele – something, I forget the exact name. Again not were not really a viable business, but great entertainment watching these two groups from the Post Cambrian slime waving their tentacles at each other, each one bragging they had more of them. Before new so called cash settlement rules came in, there used to be big standards in the MBS TBA market going back even further. To have something like a flash mob of little speculators do this is wonderful to behold!

    Re the Hedgeies, cry me a river. I need a salt water bath. Either buy some Depends, learn to control your bladder, recognize the risks that have been in markets since, say the Mississippi Company, and wear your big boy pants. Remember the term is risk / reward, it just reward. As to the complainers changing the rules in the game, that too is a grand tradition. Face it it will happen and certainly has happened before either formally or otherwise: gee back in 2000-2002 why was there naked shorting viewed with little more than loud harumps for a very long time? More formally look at the trading and delivery changes made in 12/79 – 1/80 in the silver futures market. This isn’t our first rodeo, nor will it be our last.

    Yes I am a cranky old man with questionable ting skills on a tablet or phone. If it bothers you, biEe me.

    Happy trails, etc.

    Comment by Sotosy1 — January 29, 2021 @ 12:46 pm

  18. @aaa. I’ve been waiting for a long time. I thought it would have happened long ago, so I’m no longer quoting the over/under.

    Comment by cpirrong — January 29, 2021 @ 1:37 pm

  19. Annnd the usual winners are – as usual – the lawyers. Quel surprise.

    Comment by David Mercer — January 30, 2021 @ 7:09 am

  20. a personalized story, complete with lingo and “loss porn”

    how to go from $1200 to $280,000 in 2 weeks!!

    isn’t there a “know your customer rule” for brokers???????

    https://www.cnn.com/2021/01/29/investing/wallstreetbets-reddit-culture/index.html

    also – I don’t see how hedge funds would “win” anything if they go after WallStreetBets or others – the term “judgment proof” comes to mind

    ——-

    Omar, the pre-med student who lost tens of thousands of dollars on weekly options trades, told CNN Business that he is back on WallStreetBets, trying to recoup what he lost trading money from his student loans last year. He’d bought one GameStop option which shot up to $10,000 from $7,000 amid Wednesday’s rally.

    Comment by elmer — January 30, 2021 @ 10:56 am

  21. That’s it. I completely blanked on the margin effect of T+3 settlement. I am officially senile.

    Comment by sotosy1 — January 30, 2021 @ 5:03 pm

  22. One of America’s greatest strenghts is the application of markets to determine value. Whether it is professional sport salaries, land, corn, commodities or other assets markets are the most efficient mechanism for determining the value because they react the independant “collective of the Supply and Demand”.

    Success has been based in the freedom and in free market more than in the military.

    BUT America has become “socialism for the rich, capitalism for the everyone else…”

    Over the past years we’ve seen “Capitalists” pressuring the political class to selectively dismiss capitalism (like in Europe).

    When Airlines spend all its cash to buy back their stock and then find themselves in jeopardy because of unforseen events, asking for bailout is not capitalism.

    When Hedge funds find themselves on the wrong side of a short squeeze because their manager misinterpret the market volume and short open interest realities asking for regulations, it is not capitalism.

    Markets are not easy. They are not supposed to be and this is why they reward those who are correct and punish errors !
    True Capitalists understand and accept this.

    Jeremy Grantham of GMO has strong principles and philosophy but has misread the market lately, lose his investors.

    It is pointless to to rant on the FED assets bubble or retail investors each and every other day on the television ! One must accept that capitalism is competitive market of ideas and this is what determine winners.

    the future is here .. this is tech .. this is social media … the democratization of everything .. there are traders on instagram and tiktok .. whether they trade wallstreetbets or bitcoin, they will trade ..

    if the corrupt regulators re-rig the system for their buddies in the hamptons, it will not matter, the masses will move elsewhere and everywhere ..

    robinhood sells order flow to citadel; citadel sells info to connected hedge network…..steve cohen has multiple independent trading teams that he allocates capital to; his requirement is that each trading team gives him their best idea for his own book…he does not care where they get their ill-gotten inside info from; that way he can stay “legally” clear if one of his independent teams gets caught….he is THE arch fiend wall street but he is treated like a king .. he should be in jail..

    The world has already changed and the incumbents are slow to see that….the incumbents saw a guy named jeff bezos selling books with no taxes, and laughed and ignored ..

    -A capitalist.

    Comment by Jacques S. — January 30, 2021 @ 5:23 pm

  23. more from a personalized angle

    https://www.timesofisrael.com/the-jewish-angles-to-the-gamestop-stock-saga-explained/

    The main Jewish players

    The main squeeze victims in this story are Steve Cohen and Gabe Plotkin, two Jewish investors who are also two of the most successful hedge fund chiefs on Wall Street.

    Cohen, the new owner of the New York Mets baseball franchise, had a net worth of over $14 billion as of last year. Plotkin, who once worked under Cohen, manages close to $8 billion in assets under his Melvin Capital firm. Plotkin has been honored by the Chabad Hasidic movement and worked with the Young Jewish Professionals networking group.

    The effects on their assets have been huge. So far this month, Cohen’s Point72 hedge fund has lost 15% of its value. Melvin Capital has lost as much as 30% — a bill so steep that Plotkin asked Cohen and investment firm Citadel LLC, run by Dan Sundheim, for an emergency influx of cash (which they provided, to the tune of $2.75 billion).

    But they aren’t the only Jewish characters involved. Ryan Cohen, founder of the successful pet products company Chewy, is the largest stakeholder in GameStop, with about 9 million shares, making him the big winner of the week. As of Wednesday, he had made $3 billion in a matter of days from the fallout.

    Then there’s Jewish troll extraordinaire Dave Portnoy, founder of the hugely popular blog and social media company Barstool Sports, who has emerged as one of the leading public advocates for the mass of small investors who mostly remain anonymous on sites like Reddit. More on his reaction below.

    Comment by elmer — January 31, 2021 @ 8:33 am

  24. elmer, and your point is…?
    some investors won, some lost. the fact they are all jewish is neither here not there.

    i knew there was a short countdown for appearance of some jewish conspiracy cook.

    Comment by Tatyana — February 4, 2021 @ 8:35 am

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