After small investors organized online to squeeze billions of dollars from Wall Street hedge funds, some establishment actors have come out against the investors.
The investors, mainly organized on the online Reddit forum “r/WallStreetBets,” have been buying shares of the video game retailer GameStop en masse, in the hope that hedge funds that apparently have borrowed large quantities of the stock to “short” it will be forced to buy it back at exorbitant prices, in what’s dubbed a “short squeeze.”
Some media, pundits, politicians, and financiers have decried the GameStop rush as irresponsible market distortion and argued that authorities need to step in for the small investors’ own good.
“What is dangerous, amid this trading frenzy, is that retail investors have been chasing prices so far above any sane valuation and that many will end up nursing losses,” said Jack Inglis, head of the Alternative Investment Management Association (AIMA), a hedge fund association, in a letter to members who have managed $3.7 trillion as of the third quarter of 2020.
He said the organization will help regulators with investigations.
And for the hedge funds, “those exposed will have taken it on the chin and will have executed steps to contain losses for their clients, whose savings they manage,” he said.
William Galvin, Massachusetts’s top financial regulator, also advised an intervention.
“It calls upon the regulators … to consider simply suspending it for a month and stop trading it,” he told Barron’s. “These small and unsophisticated investors are probably going to get hurt by this.”
The pushback reached such an extent that several online brokerages, such as Robinhood and Interactive Brokers, that were used by the small investors, halted purchases on Jan. 27–28 of GameStop and several other stocks that were also popular among the r/WallStreetBets crowd. Some of the restrictions have since been relaxed, allowing investors to buy at least a small quantity of the stock.
Interactive Brokers founder and chairman Thomas Peterffy, a billionaire himself, indicated that a full-blown short squeeze could make the shorts—stocks that have been borrowed and sold—so toxic as to spell financial ruin for anybody involved in the sale.
“If the short squeeze happens, the stock [value] would go to infinity practically because the shorts have to borrow the stock and once there is no more stock to borrow, they cannot deliver … so the broker has to buy in the shorts at any price,” he said, urging authorities to step in.
“Unless regulators require that trading be moved to liquidation only, this thing could go on for a long, long time and generate more and more losses,” Peterffy told Bloomberg TV.
He wouldn’t go into specifics on who were the losers, prompting the Reddit forum members to speculate that he was protecting the hedge funds.
“They didn’t have the capital to pay out the winners (us), so they took their ball and went home,” one user commented.
Robinhood first announced it imposed the restrictions because of market “volatility.” The next day, it gave further explanation, saying its clearinghouse, which validates stock purchases of its customers, started imposing exponentially higher deposit requirements on Robinhood for “a small number of securities,” apparently referring to GameStop and other targeted stocks. Because stock trades take several days to be settled, brokerages are required by clearinghouses to keep some level of deposits on hand to cover any deals that fail to settle (one side fails to pay or the other fails to deliver the security that’s being purchased).
“The required amount we had to deposit with the clearinghouse was so large—with individual volatile securities accounting for hundreds of millions of dollars in deposit requirements—that we had to take steps to limit buying in those volatile securities to ensure we could comfortably meet our requirements,” Robinhood said in a Jan. 29 statement.
Robinhood stated on Jan. 28 that it raised $1 billion from its existing investors, a move portrayed in the media as covering for the financial strain of the increased volume of trades tied to the GameStop rush.
But some of the Reddit forum members rejected this explanation and have instead speculated the cash infusion was a payoff to Robinhood for halting GameStop buys. The company denied that the restrictions were imposed “on the direction of the market makers we route to.”
“Our decision to temporarily restrict customers from buying certain securities had nothing to do with a market maker or a market participant or anyone like that putting pressure on us or asking us to do that,” Robinhood chief executive Vlad Tenev said on Jan. 29.
Some investors have already filed class-action lawsuits against Robinhood for marring investment opportunities. This also sparked a rash of negative reviews of the Robinhood app. Google then removed the reviews, calling them spam and causing further outrage.
Meanwhile, social media platform Discord shut down a related WallStreetBets forum for “hate speech,” and Facebook shuttered a WallStreetBets group for “sexual exploitation.” This further fueled the convictions among forum members that the establishment was colluding to suppress them.
It’s not clear what content specifically motivated the bans. The main Reddit forum now has nearly 8 million subscribers, making it virtually impossible that there’s no objectionable content. But there’s no sign that the general thrust of the forum is dedicated to anything beyond discussion of stocks and some juvenile, often self-deprecating humor.
Some media and commentators have suggested the forum members are partly “alt-right” or “Nazis.” No survey of political persuasions has been conducted among the small investors, but there’s no sign that the movement is driven by a particular political group.
In fact, there’s been some support for the movement on both sides of the aisle. Both Sen. Josh Hawley (R-Mo.) and Rep. Alexandria Ocasio-Cortez (D-N.Y.) have voiced their support, for example. One common political theme among the investors seems to be a general disdain for the establishment.
AIMA’s Inglis criticized the cheerleaders.
“The role of some supposedly responsible lawmakers, who have been cheering these events from the side-lines, with a knee-jerk reaction against short selling, is concerning, to say the least,” he said in his letter to members.
It appears the forum members are largely convinced that the establishment is waging a psychological war against them in order to crush their resolve and get them to sell the stocks.
Melvin Capital Management, a hedge fund that heavily shorted the GameStop stock, announced on Jan. 26 that it already closed its short position. But many of the forum members don’t believe it, arguing that there weren’t enough GameStop stocks available on the market for Melvin to close so quickly.
In many cases, stock or short ownership isn’t public information. “It’s an unanswerable question” whether Melvin indeed completely got out of the shorts, investment adviser and risk management expert Richard Smith previously told The Epoch Times.
Recently, many corporate media reported that Reddit investors are now interested in buying silver, but the general sentiment of the forum is that this is disinformation aimed at distracting from GameStop.
While some media commentators suggested that forum users organizing online to prompt a short squeeze falls under illegal market manipulation, it’s not clear how that would apply to the idiosyncratic nature of the forum content.
The forum appears to be driven by a “you only live once” mentality. Members often openly admit that their investments are risky, even foolishly risky. The established culture seems to be to tout one’s successes, and come clean on one’s failures. Proclamations of one’s lack of intelligence, experience, and means abound.
It’s illegal to spread false or misleading information in order to manipulate the price of a stock, yet the expectation of a GameStop short squeeze does have some backing in real data. There are only about 50 million GameStop shares available for public trading, and market analysts have previously estimated that up to 140 percent of that number have been shorted. That number declined to about 110 percent on Jan. 28 and then to about 50 percent on Jan. 29, according to S3 Partners. Short selling, especially on such a scale, creates pent-up demand for a stock, even when divorced from the company’s economic fundamentals.
“Whether you agree with it or not, there is value to the fact that there is a short squeeze,” said Jeff Carlson, veteran analyst and portfolio manager, in a recent interview on The Epoch Times’ “American Thought Leaders” program. The show’s host, Jan Jekielek, made clear that the interview wasn’t supposed to be construed as investment advice.
Many forum members have argued that it’s the hedge funds and the broader establishment players who have been acting illegally.
When the GameStop price dropped in the morning trading on Jan. 28, forum members called it a “short ladder attack,” which means issuing so-called “naked shorts” to flood the market with counterfeit shares and thus drive down the price. This would be illegal, but also difficult to prove.
The Securities and Exchange Commission (SEC) keeps data on “fails-to-deliver”—that is, stocks that were bought but weren’t delivered to the buyer in the allotted time (usually 3 days). The most recent data is from Jan. 14, when GameStop reported more than 600,000 outstanding fails-to-deliver. Data for the second half of the month is expected on Feb. 9.
Sen. Elizabeth Warren (D-Mass.) urged the SEC to investigate both the hedge funds and the small investors, calling for more regulation.
The SEC needs to “act to ensure that markets reflect real value, rather than the highly leveraged bets of wealthy traders or those who seek to inflict financial damage on those traders,” Warren said in a Jan. 29 letter (pdf).
But who’s to say what the real value of a company is, asked Carlson, an Epoch Times contributor, in a recent op-ed.
“The fundamental issue currently being fought over is who gets to have a role in determining financial value, access, and outcome—who gets a seat at the proverbial table,” he wrote. “Is it all the participants that make up the market? Or is it only the entrenched Wall Street players and the government regulators who want to step deeper into their role, exerting greater control and shaping desired outcomes.”
The SEC said it’s working with other agencies “to ensure that regulated entities uphold their obligations to protect investors and to identify and pursue potential wrongdoing.”
“The Commission will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities,” the agency said in a Jan. 29 release. “In addition, we will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws.”
Update: The article was updated with more recent data on short interest in GameStop stock.