The GameStop Rebellion: What Happened and What It Means


GameStop, the video game retailer, finds itself embroiled in a sort of financial hostage negotiation between Wall Street hedge funds and the unwashed masses of online investors. The GameStop Rebellion, as it has been called, brings up several important questions, which I will do my best to articulate.

First, let me bring you up to speed on what’s happening.

It All Started With Shorts

This whole thing is centered around shorts. A short is when you borrow a stock (from a brokerage house) and immediately sell it at its current price. You do this if you expect a stock’s price to fall.

If the stock’s price does indeed drop, you can repurchase it at a lower price, return the shares to the brokerage house, and pocket the difference.

For example, let’s say that you think the price of ABC stock is going to fall. You decide to short ABC stock at its current price of $10. While you now have $10 from immediately selling the borrowed stock, you also owe the brokerage house one share of ABC.

Let’s say that, soon after, the price of ABC drops to $7. At that point, you “cover” your short. (You buy ABC at $7 and return the share to the brokerage house.) The difference of $3 is your profit.

Sounds like an easy way to make money, right? Not so fast.

What happens if the price of ABC goes up instead? You still owe the brokerage house a share of ABC, but it’s going to cost more to buy it.

For example, let’s suppose that the price of ABC increases from $10 to $13. Once you “cover”, you will now lose $3.

What happens if ABC increases to $20? Or even $30? Your losses are limited only by how high the stock price can climb.

For our hypothetical ABC company, the most you could make on a short would be $10, if the price drops to zero. However, your losses could be massive should ABC start on a run. If it grew to $100 a share, you’d be $90 in the hole.

Before you know it, the brokerage house starts checking your accounts to see if you have enough money to make good.

Enter GameStop

A few weeks ago, a group on Reddit called “Wall Street Bets” noticed that Melvin Capital, a large hedge fund, had taken a sizeable short position against GameStop (GME). In essence, the hedge fund was placing a huge bet that the stock would tank.

This isn’t unusual. Hedge funds do this all the time.

Here’s where it starts getting weird.

People in the Reddit group decided that they would join together and buy as much GameStop as they could, forcing the stock’s price to rise. And rise it did.

As GameStop began to soar, the losses of Melvin Capital’s short positions mounted. In January alone, GME rose from $17.90 to a staggering peak of $396.51 per share!

The hedge fund’s potential losses climbed into the billions; some questioned if the losses were greater than the value of the fund itself. Melvin Capital would have to cover its shorts at hyper-inflated prices.

This is known as a “short squeeze“.

Melvin Capital’s losses were so massive that it needed a $3 billion bailout from two other hedge funds, Citadel and Point72. Melvin Captial has stated that it has covered its shorts, but it is unclear whether or not that’s true.

Vigilante Capitalism

Why on earth would a random group on Reddit band together to short-squeeze a hedge fund out of business? It appears that Wall Street Bets embodies a sort of populist rage toward Wall Street.

Large hedge funds have a long history of driving companies into the ground in order to profit from shorts. Indeed, it seems that Melvin Capital was doing what it could in order to drive the price of GME lower in order to increase profits.

Sadly, it’s not illegal to go on television and trash-talk a company’s stock while you own shorts on it. It’s a move that represents the most detestable aspects of Wall Street.

So Wall Street Bets decided to stick it to the Man – and make money in the process.

They intentionally tried to catch Melvin Capital in a short squeeze. And it worked. To me, that’s the most shocking aspect of the GameStop Rebellion.

In fact, it’s surprising that another large hedge fund didn’t beat this group of Redditors to the punch. It seems that Melvin Capital’s GameStop short play was clumsy and heavy-handed at best. There’s actually some question of whether or not there’s institutional money backing Wall Street Bets.

No matter whose idea it was, it’s clear these people aren’t merely Luddites throwing their stimmy checks at a failing company.

Regardless of their initial motivations, once they drove Melvin Captial to the brink, Wall Street Bets developed a taste for blood. They began searching for other hedge funds to short-squeeze into bankruptcy.

Seething Populist Rage

As Glenn Greenwald points out, while this Reddit group is being characterized as politically alt-right by the media, the motivations behind this are likely much more nuanced and diverse.

This form of populist anger toward Wall Street is non-partisan. People on the right tend to want free-market capitalism. People on the left tend to want government intervention that favors the people.

The system we have now is neither of those things.

The bailouts from the 2008 financial crisis proved that crony capitalism is alive and well. Wall Street can’t lose – if they do, they’ll just get bailed out thanks to extensive lobbying investments spanning decades.

Too big to fail, right?

In essence, we have government intervention that both interferes with free markets and fails to financially serve the interests of the general population.

It pisses off everyone except the kleptocrats.

One of the very few issues that everyone in the United States can agree upon is that Wall Street is shady and stands against the interests of average Americans. This explains why so many people are cheering for these vigilante capitalists.

For some Redditors, it goes beyond raging against the machine into the deeply personal:

this-is-for-you-dad

At the very least, there are forces at play here that go beyond the media’s portrayal of these people.

Deus Ex Machina

Just as the Wall Street Bets digital mob started converging around other shorted stocks such as AMC Theaters (AMC), the unexpected happened: brokerage firms started restricting transactions relating to these stocks.

Think about this for a second.

Firms like Robinhood, Interactive Brokers, E*Trade and many others allowed their customers to sell their positions in these specific stocks – but did not allow them to purchase more shares.

In fact, Robinhood went so far as to automatically sell GME shares in client accounts, “for their own good,” citing “unreasonable risk involved in brokering your position”.

Robinhood-how-it-started-how-its-going

Initially, there was some question whether or not brokerage-level liquidity issues led to these actions, but Robinhood’s CEO, Vlad Tenev, publicly stated that this was not the case.

According to Tenev, when Robinhood accessed their credit lines and an additional $1 billion investment infusion from existing investors, it was to meet regulatory balance sheet requirements. If Robinhood and other brokerage firms do indeed have liquidity issues resulting from this, it’s a seriously concerning issue.

So did these firms actively step in to stop retail investors from short squeezing hedge funds any further? This seems pretty illegal, but then again nobody is being arrested. Either way, a full accounting of what happened is absolutely necessary.

By the way, Citadel is a major investor in Robinhood.

Yes, the same Citadel that now owns an interest in Melvin Capital.

Implications of the GameStop Rebellion

Regardless of what you think about Wall Street Bets, the implications of the GameStop Rebellion are concerning. Why did these brokerage houses make the decision to stop allowing trades on these stocks?

Were they influenced by someone with opposing financial interests?

As you would expect, a class-action lawsuit has been filed against Robinhood and others, so this thing will continue to play out in the legal arena.

Wall Street Bets is being excoriated by the media, who accuse them of market manipulation and liken the GameStop Rebellion to the Capitol riots.

If this is market manipulation, how can you say that the industrial-sized shorting used by these hedge funds is not? It looks like regulators and politicians are starting to get involved, so we’ll soon see how the next act of deus ex machina will fall.

In the meantime, retail investors view the actions of these brokerage houses – blocking purchases of specific stocks, allowing their values to fall, and giving hedge funds the opportunity to cover their shorts – as a blatant signal that the game is rigged.

For the moment, it seems that populism isn’t going anywhere.

These Redditors certainly aren’t buying GameStop because they think it’s a good company with healthy long-term prospects. At some point, they’ll have to liquidate.

Will they hold long enough to inflict pain on the hedge funds? Have the hedge funds really covered their shorts?

We’ll have to wait and see if the GameStop Rebellion is crushed or if it turns into something bigger.

If you’re a Prana Wealth client, you’re positioned as well as possible from any potential repercussions that should occur if there’s a liquidity problem or extreme volatility.

If you’re not a client, click here to schedule a call to see if we’re potentially a good fit.

SHARE THIS POST
ipad free ebook: 5 Secrets of the Ultra-Wealthy, and How to Implement Them
Life changing guidance for your inbox
Subscribe to our monthly newsletter and grab your copy of our free ebook: 5 Secrets of the Ultra-Wealthy, and How to Implement Them