Melvin Capital’s bet against GameStop failed, and people became a bit more knowledgeable about how Wall Street works, or fails to work, because of the saga.
Part one of a two-part series
In an act of rebellion that was applauded by Americans from all points of the political spectrum, a merry band of people on Reddit have been working together to directly challenge the billionaire hedge-fund managers on Wall Street.
It started when a member of the subreddit r/WallStreetBets noticed that the shares of GameStop—a once-prolific retail video game store that has been struggling in recent years—had been aggressively shorted. (Shorting is the act of buying a share, then selling it with the promise of buying it back again later. Investors do this when they believe the price of a share will drop, so that they can buy it back for less than they sold it for).
Shorting can be a normal and healthy practice in the stock market, but in this case, it was so egregiously aggressive that hedge funds, mainly Melvin Capital, were shorting 140 percent of the total shares. Shorting more shares than are in existence is called “naked shorting,” and the Securities and Exchange Commission made it illegal in 2008.
Aggressive predatory practices like this have been a driving force in bankrupting far too many businesses over the past few decades, and GameStop was just the newest target. When a trader shorts a business, and that business goes bankrupt, the trader makes a significant profit. This induces some people to see collapsing business as a lottery ticket. Many hedge fund short sellers[DL1] will even take an active role in financially destroying underperforming businesses as quickly as possible in order to expedite their own gain.
Aggressive predatory practices like this have been a driving force in bankrupting far too many businesses over the past few decades, and GameStop was just the newest target.
For example, in March of 2020, Bill Ackman went on CNBC for 30 minutes to talk about the effect of Covid-19 on the economy, using such dramatic lines as “death of the economy” and “assume it will kill your child.” He also named specific stocks like Hilton, saying that the share price would “drop to zero.” His interview is directly correlated to the collapse of the stocks he named, which he conveniently shorted before the interview. And many analysts believe such theatrical statements may also have contributed to the overall market drop.
But while he acted as if the impending calamity was something to fear, he stood to profit $2.6 billion. To reiterate, a hedge fund founder made a bet that stocks would crash: he stoked fear among millions via national television, his words became a major force in the ensuing market crash, and then he made $2.6 billion from it. He did this while the rest of us were losing jobs and savings.
In a capitalist society, a person should be free to make honest investments in the stock market. But is it capitalism when someone forces a business to go bankrupt, not by competing with their product or service but by gambling against them and manipulating others to think negatively of the business? Folks on Reddit didn’t think so, and neither do most Americans. These predatory economic practices have bankrupted businesses and ruined job markets across the country for nearly 30 years while yielding no benefit to the American people and our economy.
This isn’t so much capitalism as it is piracy.
But is it capitalism when someone forces a business to go bankrupt, not by competing with their product or service but by gambling against them and manipulating others to think negatively of the business? Folks on Reddit didn’t think so, and neither do most Americans.
So, when some knowledgeable users on r/WallStreetBets noticed the aggressive hedge-fund short selling of GameStop shares, the subreddit banded together to buy up the GameStop stock and raise its price. By working together, they planned to simultaneously profit from the short position taken by Melvin Capital and stop them from essentially looting an underperforming American business. What followed was a back-and-forth battle between Reddit and the hedge fund. Melvin Capital doubled down, then tripled down on their short-selling gamble, while Reddit investors, fueled by a mixture of boldness (bordering on recklessness) caused by current financial and social circumstances, continued to pour money into the stock.
In the end, the hedge fund lost more than half of its money, and a few Redditors made a great profit. Many others ended up losing out on their investments when the GameStop stock inevitably dropped. But even many of those who lost money voiced pride in having participated in an effort to make Wall Street sweat.
GameStop will now live on much longer than Melvin Capital ever expected. That means the workers of GameStop will stay employed, and perhaps new jobs and business innovation will come from this influx of cash. Melvin Capital’s attempted siege against the decades-old American business failed, and people have become a bit more knowledgeable about how Wall Street works, or fails to work. It’s a story everybody can enjoy.
Well, almost everybody.
Read Part 2 here.
This article was originally published in Broad + Liberty (rights retained by me) on February 24th, 2021https://broadandliberty.com/2021/02/24/daniel-goncalves-reddit-investors-vs-hedge-fund-billionaires/