On January 27, the stock market was turned on its head completely when a massive internet revolution caused a short squeeze of several seemingly dying stocks, including a company our generation grew up with. The share price of Gamestop Inc. went from closing at $39.12 a share on January 20, to closing at $347.51 a share just a week later. This meteoric rise came as a surprise to many who assumed that Gamestop would keep losing value because its business model was being eclipsed by new technology (specifically online game delivery). Among those predicting the fall of Gamestop were prominent Wall Street investors whose hedge funds were forced to sustain huge losses as a result of this unpredicted stock price escalation. At the core of this chaos was a Reddit online investing community called Wallstreetbets (WSB), where members were strongly encouraged to buy up Gamestop stock in order to drive up the share price and force a short squeeze, and the stated (and unapologetic) intent was to punish large hedge funds holding short position on this stock.
What is a Short/Short Squeeze
In Wall Street terminology, a “short sale” is basically a bet against a stock, or a bet against the success of a company. Let’s say there is a worldwide shortage in tomatoes, and you believe that it will hurt the ketchup industry, so you decide to take a short position in Heinz. You would “borrow” Heinz stock from your broker, and sell it at its current value, for the purpose of this example $10. Once the price of Heinz stock drops, you can purchase shares at the lower price, let’s say $5. You then return the stock to the lender you and have made a $5 profit. Successful shorts can be extremely profitable – for example, hedge fund manager Michael Burry invested over a billion dollars into a short of the housing market in 2005, predicting that it would fall apart. When it did, Burry made a 489% profit, taking in a profit around 2.7 billion dollars for his investors (while the market went into freefall, leading to a crushing recession). However, shorts are high risk investments, because if a stock price does not fall as predicted, the short seller is forced to “cover” their position, meaning they are forced to buy it back on the open market (in order to return it to the lender) at a higher price. This makes the downside infinite, as a stock can rise infinitely but cannot be worth less than $0. If the short seller bets correctly, and the stock value has dropped, they make a profit on the investment, but if the stock has risen, they lose money on the investment.
How Does Robinhood Play Into This Situation
On January 28, prominent free trading app Robinhood (ironically named) halted buying on some specific stocks (including Gamestop), while retail brokerages were able to continue trading in the stocks. This had the effect of temporarily stopping the Gamestop stock’s price rally and allowing some of the larger Wall Street investors to recoup some of their losses. This was very controversial, as Robinhood had branded themselves as a company to aid “the little guy”, a tool to put the “average investor” on the same playing field as a Wall Street investor. So to take such an unusual measure that directly benefited those Wall Street investors made them appear hypocritical, at best, and corrupt, at worst. There has been mass speculation about what inspired this decision, although Robinhood has stated that this action was directed by their “clearinghouse”, the entity which ensured that brokerages such as Robinhood had sufficient funds to cover their positions. The stock price of Gamestop had risen so high that Robinhood would not have enough liquidity to pay off all of the people who were likely to cash out, which would have constituted a “regulatory violation”(see below) by a financial brokerage. Some pointed out that the Robinhood app was initially capitalized by Wall Street money , and speculated that Robinhood had succumbed to Wall Street pressure. Whatever the reason, the decision to halt buying did drive the price of these stocks down, and caused outrage from those who already believed that the market was “rigged” in favor of the Wall Street behemoths and against the everyday small investor.
How Will This Affect the Stock Market Moving Forward
While it would seem at first glance that the Reddit revolution was a true “Robin Hood”operation – allowing the small investor to profit at the expense of the Wall Street giants – in fact it is not that simple. Keep in mind that many of these Wall Street hedge funds invest money for government pension and retirement funds, such as firefighters, policemen and teachers unions. It is scary to think that a Reddit revolution could drain the retirement funds of hardworking civil servants and public service workers in this way. This is an excellent example of how social media can be dangerous and misleading. While the concept of the financial “bubble” has existed for centuries, and this is not the first time that a seemingly “no-lose” financial opportunity has driven illogical and counterintuitive investor behavior, the rise of social media has significantly exacerbated the extent of the damage potentially caused by these trends. Social media has the effect of more quickly and effectively disseminating information about such trends, as exponentially more people can – and do jump on the bandwagon from fear of missing out.
However, this is the first large scale example of social media directly encouraging stock manipulation, and a frightening example of how an online trend could have devastating economic effects on real people. Companies’ stock prices generally go up because of something within the company that is positive, increases efficiency or productivity, has potential, is new age or attracts the new generation – for example, a new technology, a merger, or new management. Buying stock in TikTok because it is becoming the number one social media app, or buying stock in Disney after the release of Disney plus, are examples of companies becoming more attractive to investors in this way. Gamestop does not fall under this category, as the most compelling reason emphasized by the members of WSB to drive sales of the stock had no relation to the growth potential of the company itself (although, despite outdated technology and bleak sales prospects, some of the original proponents of Gamestock saw growth potential due to the increased involvement of Chewy co-founder Ryan Cohan, as described below). Somehow though, with few redeeming qualities and questionable potential for the future, the WSB followers decided to take this stock and drive it to the moon. Is that market manipulation?
What is Market Manipulation
Market manipulation is the practice of artificially inflating or deflating the price of a stock for some separate motivation. Said another way, it is a deliberate attempt to disrupt the fairness and freedom that are pillars of a capitalist economy, and is generally understood as spreading intentionally misleading and false information about a stock in order to depress or inflate its value and present an attractive buying or selling opportunity to the manipulator.
,Is This A Case of Market Manipulation
Should the actions of WSB be considered market manipulation? Is the concerted effort of a group to pump a stock with malicious intent unlawful? Would this even be considered unlawful by any if there was no malicious intent? Gamestop stock did go up organically last year, from around $4 a share to $25 a share, due to a significant new addition to their board of directors, and some industry experts truly believe that it has a bright future. Does this provide enough reason to believe that this monumental rise in price was not artificial, and was not market manipulation? Does that fact that the chat room where this plan was hatched is 100% public affect whether this was market manipulation? One of the basic principles of the “fairness” of the stock market is that everybody is playing with the same information, and WSB is a public domain. That being said, intent is also a major factor in what constitutes market manipulation. If the intent was to pump a meaningless stock to drain hedge funds, then that is arguably illegal, and possibly criminal.
Will There Be Government Regulation Against This in the Future?
Questions have been raised concerning the government’s regulatory role in this situation. Putting aside the question of whether this concerted action was legal or not, some are calling for there to be specific statutory or regulatory language to prevent this from happening again, in an effort to stabilize the market. But any such new laws or regulations would have to balance the interests of all investors, big and small. While large investors have traditionally had more market power, new ways to bring small investors together and disseminate information are leveling the playing field. The question is to what extent are artificial restraints on market behavior appropriate, and at what point do they interfere or come into conflict with the basic principles of a free market? While insider trading is clearly illegal and an appropriate restraint, at what point should an investor’s motivation be judged if his or her actual behavior is arguably within the bounds of legality? In this unprecedented time, how will the legislative system come up with something that can stop this insanity in the future without swaying the market in favor of Wall Street? Is there there a change to be made in the market itself? It will be interesting to see the governmental response to this and how these conflicting interests will be balanced..
Confidence in Market Going Forward
Another important question to consider is that without governmental regulation to prevent situations like this in the future, will people lose confidence in the market? As people lose confidence in the market, will they pull out their money, causing economic destabilization? Once everybody starts pulling out, the market destabilizes as market prices crash to rock bottom. Unfortunately, there is no real positive spin on this as to why this should be seen as a positive, and without those positives, nobody will want to invest their money in the stock market, and the downward spiral will gain speed.
I personally believe that the entire situation was difficult for Robinhood from the start. In a perfect world, they would have stayed true to their name, and not interfered to stop the momentum of these stocks. In reality however, they simply did not have enough liquidity to pay off everyone who would be taking out their money at the same time, and since their backers were the ones getting killed in the market, they found themselves stuck between a rock and a hard place. The mistake that Robinhood made, however, was a lack of transparency with the public right away, because the ensuing radio silence caused people to formulate their own explanations for Robinhood’s decision to halt buying, which were generally more suspicious or conspiratorial than the truth. It was a lose-lose from the beginning for Robinhood, as they had a choice between ruining their public image, or violating major regulations and angering their investors.
Looking ahead, I feel that the SEC must regulate this behavior to prevent future abuses. Sure, it was fun to see a virtually worthless stock skyrocket to be more valuable than the blue chip stocks. Sure, proving that this was market manipulation would be nearly impossible under current guidelines. With all that being said, it is just too dangerous for an internet flash mob to be able to turn the tide of the stock market because they feel like it, and even more so if the intent is malicious. To put it bluntly, that is exactly what this was: a virtual flash mob. The investors who really drove the price up did not do so because they believed in Gamestop. The hope for the market is that stock price generally mirrors the value of a company, or the predicted value of a company, and when that ceases to be the case, the most important part of our American economy becomes a casino. If there is a way to prevent a repeat of this situation in the future without shifting the entire dynamic of the market, it must be implemented to avoid our already-volatile market from becoming completely unstable.