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29 January 2021

The Big Squeeze: How financial populism sent the stock market on a wild ride

The sudden moves in the stock prices of GameStop and other companies have been hailed as a revolution in investment. Is this true, or are the same people getting richer? 

By Will Dunn

Almost ten years to the day since Adbusters magazine sowed the seeds of the Occupy movement with a call for “a popular uprising in the West […] a million man march on Wall Street”, the news media is captivated by the story of a group of retail investors who have apparently kept the video game retailer GameStop alive by causing its stock price to rocket – and beaten hedge funds at their own game.

“Meet the amateur traders fighting Wall Street” gushed the BBC this morning, presenting an audience of 438 million people with the stories of a few plucky individuals – normal people, just like us – who used financial trading apps such as Robinhood to support GameStop and combat the destructive cynicism of the financial elite. 

This is financial populism, and it has become a powerful force in stock markets. Just like political populism, it makes simplistic promises of self-determination and enrichment to “the people” who have been taken for fools by the rich and powerful. And just like political populism, it responds to the presentation of any facts that contradict its narrative with outrage.

Earlier this week, as the volatility in the stock prices of GameStop and other companies became extreme, the popular trading app Robinhood began limiting the ability of individual traders to speculate on these stocks. In the last 24 hours, populist politicians from Nigel Farage to Alexandra Ocasio-Cortez, have taken to social media to excoriate Robinhood for handing control back to Wall Street.

But this is not a simple case of ordinary people pulling down the castle walls; populism never is. In the excitement of such moments it is important to asked who the vested interests are, where the money is going, and who, in the end, will pay. 

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The bad guys in the populist story are short sellers. These are hedge funds that speculate on the stock price of companies with other people’s money. 

Short selling involves borrowing a stock, selling it immediately, and agreeing to buy it back later. It’s a bet, effectively, that a stock’s price will fall: if you open a position on a stock by “selling it short” at £10, then close your position by buying it when it has dropped to £2, you pocket £8 (minus interest on the loan, and fees). This can be very lucrative, but it is also extremely risky: if the stock price goes up, there is no limit to the amount you can lose.   

The hedge funds that bet against GameStop thought they were buying an insurance policy on a building that was already on fire. Video games are booming: the pandemic has not disrupted production, and it has hugely increased demand. Worldwide revenues from the industry in 2020 topped $159bn. But 2020 was also the year in which downloaded games exceeded physical copies for the first time. Selling games on disc – GameStop’s core business – is dead.

Not everyone was prepared to accept that, particularly on the web forum Reddit. As a group, Reddit users are most likely to belong to the same demographic as regular gamers – young and male. GameStop is a brand this cohort knows, and may view with some nostalgia. So when members of the WallStreetBets subreddit began posting last autumn that Ryan Cohen, the founder of the online pet food retailer Chewy, could save the company, people wanted to listen. They were able make a compelling case to the subreddit’s members (which then numbered in the hundreds of thousands, but has since swelled to millions) that GameStop could be turned around: after all, Ryan Cohen had turned Chewy into a $10bn business. Was GameStop a Netflix waiting to happen?  

These posts rejected or ignored other fundamental problems: that Chewy has never made a profit, for example, or that even if GameStop could pivot to making and streaming games – and it is not thought to own any proprietary technology to do so – the company would be entering a market in which its direct competitors would be Microsoft, Apple and Google.

Beneath this enthusiasm, however, was a colder and more rational incentive. What the WallStreetBets subreddit’s more experienced traders had noticed was that the hedge funds betting against GameStop’s stock were so confident it would go down in price that they had, by taking “synthetic positions” (borrowing and selling stocks that had already been borrowed and sold by someone else), shorted more than the value of the shares available. This made the hedge funds vulnerable to a “short squeeze”: a situation in which, when the price of a stock rises, short sellers are left scrabbling (and paying through the nose) for shares to close their positions.  

It’s worth pausing to ask whether someone who has the knowledge and the capital to make this happen – the Reddit user who began the GameStop investment cascade placed an initial investment of $53,000 on the company – can be called an “amateur trader”. But where one user led, others followed.

By persuading fellow Reddit users to buy and hold GameStop, and by buying derivatives on the stock – which can also cause the price to rise, as the financial institution selling the derivatives buys the stock itself to lower its exposure to price changes – WallStreetBets created a short squeeze. Hedge funds such as Melvin Capital faced a steeply rising stock price and a lack of stocks to close their positions.

As the price spiked, WallStreetBets users goaded each other to “hold the line”, unleashing furious contempt on anyone who sold their GameStop stock. As its price changed, users who held on and lost money were applauded by the community. One popular meme that has been doing the rounds uses a scene from the 2008 Batman film The Dark Knight, in which the Joker burns a huge pile of banknotes while saying: “It’s not about the money. It’s about sending a message.”

At its peak, the GameStop price increased by more than 1,700 per cent. The user who made the first post about the stock had made $50m. Analysts at S3 Partners estimated the losses incurred by hedge funds at $5bn. And WallStreetBets – now with around twice as many readers as the Wall Street Journal – went looking for other shorted stocks to squeeze.


So does taking on the short sellers make Reddit users the good guys? Ro Khanna, a Democrat congressman who represents Silicon Valley, summed up the popular resentment towards hedge funds in a statement he released on Thursday (28 January), in which he claimed that “Wall Street poured billions into shorting this stock to crush [Gamestop] and put workers out of business”.

But shorting a stock does not put a company out of business, any more than betting on a horse makes it run faster. And day trading of derivatives is not investment, is it speculation. It is gambling.

Imagine a horse – let’s call him Old Gluey – who has, at the age of 58, three working legs and a worrying cough. Gluey becomes a social media star and his fans begin a craze for betting on him. Would Ocasio-Cortez be similarly outraged if a bookmaker temporarily restricted people’s ability to gamble on the #Gluester?

As S3 Partners pointed out in its statement, even after hedge funds lost $5bn: “We are seeing extremely strong demand from new short sellers looking to initiate new short positions.” The continuing appetite to short GameStop strongly suggests the extent of the company’s fundamental weaknesses. The horse, in other words, is on its last legs, whether people want to bet on it or not.

The moments during which Robinhood has been overwhelmed by demand also give some insight into who is really making money from this volatility. Even as retail trading apps closed off trading to amateurs like the Redditors, other investors were executing trades worth hundreds of millions on platforms available only to investment professionals. Is WallStreetBets moving markets, or is it just offering a useful barometer for those same institutional investors its users despise?

Indeed, the biggest winners from Gamestop’s stock price are likely to be those who held shares prior to this trading frenzy. That includes very rich individuals such as Donald Foss, the former subprime auto lender who bought 3.5 million shares at rock-bottom prices in February 2020, and enormous institutional investors such as BlackRock, which owns 13.2 per cent of GameStop shares. With $8.7trn in assets under management and three of its former executives now in the Biden administration, BlackRock is as much a part of the Wall Street establishment as it is possible to be.

And the people cheering on the GameStop speculators include the billionaire short seller Mark Cuban, and Elon Musk, who is – also thanks to market exuberance – currently the richest man in the world.  

[see also: Is Tesla a car company, or a casino?]

The little guys that neither Farage nor Ocasio-Cortez appear to have considered are the 53,000 people who work for Gamestop, whose jobs may depend on the outcome of a poker game between institutional investors and an online mob.

In terms of the bigger picture, does anyone really believe, after five years of buoyant political populism, that financial populism will create, as Ro Khanna writes, “access and equality across every sector of our economy”? Will it bring about what Occupy Wall Street set out to achieve ten years ago?

Anyone who thinks this might be the case should look at what is, at time of writing, the most widely discussed investment on social media: Dogecoin, a useless cryptocurrency, created as a joke in 2013, into which amateur investors have poured $7bn. It will continue to grow, but it will only do so while there is a supply of credulous opportunists to gamble on it. Some people will make a lot of money from Dogecoin, but a much greater number of people will lose their investments if and when Dogecoin’s value collapses. People are free to risk their money, but politicians should not encourage them via the fantasy that doing so will somehow solve economic inequality. 

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