Last January an event occurred on the New York Stock Exchange that made national news: the stock of a company called Game Stop, a video gaming vendor, rose from $17 a share at the beginning of the month to $414 by the end of the month. This alone would not have been newsworthy, stocks rise and fall dramatically all the time. What made this particular instance newsworthy is that it almost bankrupted a leading Wall Street hedge fund, Melvin Capital, which had gone short on Game Stop bigtime.
When you “go short”, it means you are betting the value of a company’s shares will fall. You contract to borrow a certain number of shares of a company and promise to return the same number of shares to the lender at some later date. To illustrate, let’s say you borrow 1000 shares of a company that are selling for $100 a share. You sell the borrowed shares immediately, getting $100,000 for them. On the date you must return the shares, let’s suppose the price of a share has dropped to $60. You purchase 1000 shares for $60,000, return them to the lender, and make a profit of $40,000.
That’s what Melvin Capital was betting on with Game Stop; but, since the share price rose instead of fell, they had to pay a lot more for the shares they had borrowed than what they had sold them for initially. Melvin Capital suffered a 53% loss on its bet and it had bet so much (in the billions) it might have had to declare bankruptcy had two other hedge funds, Citadel and Point72, not bailed them out.
I find the Game Stop story very illuminating as to how Wall Street works—and heartwarming, in a way, in that it’s a David and Goliath tale (Spoiler alert: the moral of this all-too-real fable is that the price of shares on the stock exchanges can be and are manipulated). What is believed to have driven Game Stop’s stock through the roof was a campaign waged by some tech savvy, independent day traders (traders who engage in very active intraday trading in hopes of profiting from short-term changes in stock prices) to promote Game Stop’s stock, utilizing a social media discussion platform called “WallStreetBets” to get the word out. They were so successful the stock went viral, resulting in hundreds joining in and pushing the price of the stock up into the financial stratosphere.
The day traders appear to have been motivated as much by a desire to punish the multibillion-dollar hedge funds as the hope of making a killing. These enterprising, aspiring capitalists held a grudge against the hedge funds, feeling they had lost money in the past because the funds gamed the market. They decided to pay the funds back in kind. As one of the day traders, Jon Hagedorn, explained, “There needs to be a hard, hard look at what mechanisms and tools hedge funds use when they are shorting companies. Retail investors and investors in general have to feel it’s a level playing field, and right now it certainly doesn’t feel that way.”
Hagedorn did not specify how the hedge funds were tilting the playing field, but I’m guessing he suspects the hedge fund engage in their own game of price manipulation. I think he’s right; and, if a crowd of smalltime day traders can do it, how much easier must it be for Melvin Capital, Citadel, Point72, and the other hedge funds, with their huge assets, to do it even bigger and better. Some even believe hedge funds were involved on both sides of the Game Stop affair, that the day traders were just “useful idiots”, as Lenin would call them, used to misdirect those investigating the scheme away from the real culprits. That one hedge fund which went long on Game Stop (bet on its stock going up) made 700 million dollars off the skyrocketing stock lends credence to this belief.
Imagine making 700 million dollars without contributing one iota of value to society’s betterment! Contributing some fraction of such stupendous gains to build a library (with one’s name on it) at your alma mater hardly absolves a fat-cat donor from having committed what should be a crime, if his wealth was acquired by gaming the market.* No wonder speculators were singled out by Lenin for special treatment: “speculators must be shot on the spot.”** And today’s hedge fund puppeteers dwarf the speculators of Lenin’s time in terms of the fabulous wealth that can be acquired illicitly. That economic theorist revered by devotees of free enterprise, Adam Smith, hit the jackpot, so to speak, when he noted the anti-social tendency of the businessmen of his day, a tendency which applies equally to those of our day: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public.”***
It’s disconcerting for those who care about this country that short selling has become so ubiquitous on Wall Street. The fabulous profits hedge funds gain from this high-stakes gambling—often earning a 20 to 30 per cent return on their investments—has got to be a major contributor to the inequality which is destroying America’s social cohesion. Quoting Adam Smith again, “ No society can surely be flourishing and happy, of which the greater part of the members are poor and miserable. It is but equity, besides, that they who feed, clothe, and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, clothed, and lodged.”**** Our Fast-fingered Finaglers of High Finance would do well to remember the fate which befell the speculators in Tsarist Russia condemned by Lenin.
———————————————————
* And it is a crime! Price manipulation is a major no-no for the Securities and Exchange Commission, the body established in the wake of the stock market crash of 1929 to assure that the abuses which brought on that crash are not repeated; but the SEC has not been totally successful in this regard. As one market analyst explains, “The SEC rarely brings manipulation cases at all — they accounted for just 5 per cent of enforcement actions in 2019-2020 — and almost never in cases where they are not alleging deception.”. With regard to Game Stop, no charges have been brought so far. It’s not illegal to encourage others to buy a particular stock, as the day traders did and as brokerage houses do all the time—that’s their business, after all. Moreover, it’s hard to prove price manipulation, if the manipulator doesn’t get too greedy, acts in collaboration with other manipulators to obfuscate things, and doesn’t leave a paper, telephonic, or digital trail.
** As quoted in Meeting of the Presidium of the Petrograd Soviet With Delegates From the Food Supply Organisations, Collected Works, Vol. 26, page 501
*** The Wealth of Nations, Book 1, ch. 10, Part 2, p. 152. The first short sale in modern history occurred in 1609 when a speculator shorted the stock of the Dutch East India Company; appalled at the practice, the Amsterdam Exchange prohibited short selling a year later. Plus ça change, plus c’est la même chose.
**** The Wealth of Nations, Book 1, ch. 8, p. 94
Ken's Blog 
Adam Smith made an insightful comment which helps explain why we let the hedge funds get away with their antisocial behavior: “This disposition to admire, and almost to worship, the rich and powerful, and to despise or, at least, neglect persons of poor and mean conditions, though necessary both to establish and to maintain the distinction of ranks and the order of society, is, at the same time, the great and most universal cause of the corruption of our moral sentiments.” (“The Theory of Moral Sentiments”, Sec. III, ch. 2)
LikeLike