A timeline of stonk: What GameStop has taught us about regulating our markets
By Thaea Deilami, April 8 2021—
Reddit’s r/WallStreetBets is not done swaying the market, and I — in reverent worship of the likes of Chris Rock’s coming-of-age autobiographical series and the trifling Persian aunties paving the way before me — aim to narrate this saga like the aggressively stubborn and strongly opinionated individual I am.
In January 2021, a new age of internet investors swept in to punish Melvin Capital, which was on the point of collapse, before being bailed out by other firms after borderline-illegal naked short selling.
Here’s a quick crash course:
As investors purchase stock, the stock price will increase. Likewise, should stocks be sold off, the stock price will see a decline in value. Short selling is the practice of betting against a corporation’s stock price. This is done when a party foresees that the stock price will likely fall and desires to make a profit off the falling value of the stock. Stocks will be borrowed from the stock brokerage where they are intermittently pulled from other investor’s portfolios with the caveat that the stock must be returned to the lenders. The investor shorting the stock will sell the stock, and buy back the stock when the share value drops, making a profit from the difference. When you buy a stock share, you limit your risk, as you can only lose the amount that you invested. When you short a stock, you undertake unlimited risk, as theoretically the stock price could keep rising and you would eventually have to buy back the stock, regardless of the losses incurred in the difference between selling and repurchasing the borrowed stock. I know it’s a tricky concept, selling a stock you don’t own. Do yourself a favour and look up a Youtube video on shorting because it’s going to get messier.
Naked short selling refers to the act of shorting more stocks than can be located from lender portfolios. Essentially, the brokerage is selling shares that may not even be existent. It is illegal to naked short sell in Canada, as well as in the United States, with the exception of market makers — although the practice is still regulated and frowned upon. Market makers are the institutions that provide liquidity to financial commodities and ensure a consistent trading volume in the market. Market makers in America are exempt from having to locate stocks to short as they have much larger trading volumes, resulting in the prospect of having to locate stocks to borrow as a hindrance to market flow.
GameStop, being listed on the New York Stock Exchange (NYSE), is an American stock. GameStop was naked shorted by Melvin Capital, Citadel and other hedging firms and investors, with over 140 per cent of its shares shorted. Even more tragic to the tale was the toll that naked shorting was taking on GameStop. The sheer extent of shorting was generating shares that did not even exist. As the total amount of shares being generated put additional phantom stocks that do not technically exist into circulation, the share value continued to decrease due to the increasing share number — similar to inflation. As the shares decreased in value, shareholders continued to retract their investments and liquidate their stocks, knocking down the share value towards an even steeper drop. If GameStop had fallen as shorters had hoped — plummeting the stock price to zero — the company would have folded and shorters would not have been liable to return the shares as the shares would have been worthless. Such was the greed of the hedging world. They would have gotten away with it too, if it weren’t for those meddling kids.
Enter r/WallStreetBets into the hustle. In early January, investors on Reddit began generating steam when a subreddit known for selecting bullish stock picks began to take notice of financial analyst and recreational investor Keith Gill’s adamant endorsement of GameStop. When the community caught wind of the exceptionally peculiar numbers presented regarding trading activities involving GameStop — courtesy of r/Isthiswittyenough92 — decisive action was taken to, for lack of a better way to put it, smite the shorters. With all the hate for the establishment in their precious little hearts, they rallied their subreddit forces, fired up their trading accounts and picketed their memes. It wasn’t long before GameStop value came up from its once measly $2.80 earlier in the pandemic to a peak of $347.51 per share. A handful of Redditors made considerable fortunes ranging in the millions, while the hedge funds who had picked the wrong business to play highwayman with were left trying to figure out how not to go under.
This resulted in a short squeeze, where the shorting party is forced to sell their shares, as prices climb, in order to make good on their expectations to return the stock. Hedge funds were amassing a considerable loss as they were forced into buying back stock that they had originally sold for a fraction of the current value. Due to the sheer amount of shares that the hedge funds were good for, short sellers contributed to their own demise as they were forced to buy back shares at immense prices. As they continued to buy shares, the value of Reddit’s favourite comeback stock continued to reach stratospheric proportions — to the point where GameStop was inducted into the Fortune 500 index early this year. Stock shares resurged from $45, rising to $265 on March 10 and continue to stay strong after renewed vigor amongst Reddit r/WallStreetBets hopefuls.
Melvin Capital was one such corporation that lost billions, succeeding to a 53 per cent loss on positions and was required to be bailed out by Point72 and Citadel. Citron Research lost 100 per cent of its positions and has since entirely restructured their approach to markets. The situation became so complex that trading platform Robinhood put a halt on Gamestop stock purchases, alongside the purchases of several other high trade volume stocks. Many believe that Robinhood overstepped to provide relief to short squeezed hedge funds. Others state that the high volatility of the stocks paired with the fact that stocks do not settle for two days, created a credit risk for the trading platform, as well as a shortage of funds to post for deposits, for which they were within their rights to protect their financial and legal interests.
I’ll admit, I’m underqualified to point fingers, I’ll leave that to the courts. Regardless, the fallout was immeasurable and negative perceptions of economic institutions were only exacerbated. Federal investigations ensued. A class action lawsuit is now underway against Robinhood. Meanwhile, corporations like Citadel Capital were making profit regardless, as they facilitated trading on behalf of brokerages such as Robinhood. In December of 2020, Robinhood was fined $65 million by the U.S Securities and Exchange commission for failing to disclose the “payment for order flow” model of pricing which resulted in Robinhood receiving commission from firms such as Citadel who Robinhood would routinely route customer orders to. Robinhood’s claims to match or beat the pricing of competitor brokerages while charging no trading fee was deemed to be disingenuous. The pricing model was misleading because investors were routinely paying worse rates for stock trades. Thus, it was established that Robinhood’s primary customers are other firms, not the retail investors they claimed to champion.
On the downside, the creation of phantom shares — which as stated before are shares that are procured and shorted that technically do not exist — would leave many traders without tangible shares. Notably, some newer traders did undertake considerable losses by buying high and selling low when the stock had seemed to settle. Despite Wall Street’s radical tactics such as egregious naked shorting that they are technically not supposed to employ, r/WallStreetBets has charged towards Wall Street with equally aggressive trading tactics, if not a little less researched — or sane. What is meant by this is that sometimes investors break through to profits by utilizing loopholes in traditional trading strategies that have slim chances of success. What usually ends up occurring is that investors end up a couple thousand short of what they originally had, which wasn’t very much to begin with. What’s a couple thousand dollars subtracted from a mounting post-secondary tuition loan anyways, to a worker who’s been laid off because of the pandemic, with no reasonable source of employment in sight for anyone who isn’t vastly overqualified? While we might not be the best prepared — as during the GameStop stock purchase frenzy some novice investors accidently purchased GME stock on the Australian ASX exchange instead, which is actually the ticker symbol for GME Resources, not GamesStop — we are desperate and we are ready to risk it all. To all the Redditors who at least followed through and tried to show up to the crusade even though you got the stock wrong, let alone the entire stock exchange wrong, you’re doing great sweetie.
The story doesn’t end with GameStop. Other similarly shorted companies that the internet has come to know as meme stonks are gracing Wall Street’s doorstep with their expensive and over-valued presence. Several hedging firms barely walked away after the series of short squeezes and are still donning the bruises. Looks like Palm Springs is cancelled this year for thousands of young up-and-coming hedge fund lackeys. They sold their souls to capitalism’s evils and it didn’t pay off well. Bad investments happen sometimes, we’re sure they understand. Some less fortunate souls may slip through the cracks and only receive a small loan of a million dollars to get by on. I’m sure a Go Fund Me at their behest could be organized. Thankfully, they can’t naked short this one.
My seething sarcasm and amusement aside, while I am definitely not waving any foam fingers for the establishment in its current state, I see the merits in shorting.
By drawing attention to cracks in corporate disclosures and operations, shorting firms draw auditors to the worst market offenders in cases that may have otherwise gone unnoticed. Hedge funds fill the extensive initial market investigation gap that public auditors simply cannot undertake with their limited resources. Additionally, they are willing to put down their money to back their bluffs. The incentive for hedge funds to get paid through shorting gets unethical corporations bent. That doesn’t mean their interests are always parallel to public interest. Other times, shorters can be vultures speeding along unnatural corporate deaths by dragging out unnecessary public scrutiny through polarized research papers that smear the corporation, not always on a warranted basis. In Canada, although naked short selling is illegal, McMillian LP published a study outlining how Canada’s relaxed approach to regulating markets created space for large hedge funds to prey upon Canadian firms and distort share prices. Today’s Canadian mining industry is so heavily impacted by shorting that campaigns have emerged to revitalize and protect the industry from shorting sharks.
So, who was chaotic good and who was chaotic evil? Are some people inherently good or inherently bad based on their personal financial actions? Are people chaotic good and flawed systems chaotic evil? I’m still deciding myself. I am the everyday Redditor with a trading account. I am the riled millennial who will likely spend a long time fixing what previous generations have broken with their greed and systems of traditions. Yet, we live in a meritocracy where, as long as we act within the parameters of our legal system, we deserve to reap the benefit of our endeavours. That means our current systems and where they stand need to be revisited, as they should not be molded by the financial institutions that they need to successfully contain. As journalist Lucy Komisar puts it, the scam that is naked short selling has been permitted and overseen by the Securities and Exchange Commission (ESC) and the Depository Trust and Clearing Corp. (DTCC).
“The SEC has long been run by revolving-door officials who move between it and Wall Street trading houses and law firms. DTCC is owned by the prime brokers, such as Goldman Sachs, JPMorgan and Citi, and run in their interests,” she says in her article.
Beyond just advocating for ourselves, we need to advocate for each other and future generations. We are now learning to achieve change by playing by the rules of institutions, using the tools we have available to us. According to Bloomberg writers, Kumar and Parmar say that Redditors have incited such anxiety in short selling firm circles that some firms now have a dedicated staff member for analyzing Reddit trading forums. In the meantime, firms like Robinhood and short sellers involved in less savoury schemes have awoken us to the gaps in our market regulations, as well as conflicts of interest when it comes to assigning regulators. Personally, I think the two sides keep each other vigilant. We are afloat on a lifeboat and the conspicuous tigers of Wall Street are the only thing keeping us alert and therefore alive. So long as we feed into their markets, they should keep in mind that we are what keep them prosperous. Antagonistic catalysts are just an early favour to cash in for the future that I have come to grudgingly appreciate.
This article is part of our Opinions section and does not necessarily reflect the views of the Gauntlet’s editorial board.