What looked like a perfect storm for the economy, markets, health system, and politics was amplified by a group of retail kamikaze investors that hung out on a Reddit conversation group. To start the drama, a group of hedge funds identified GameStop’s stock as overpriced. GameStop is a floundering brick and mortar chain store dedicated to sales of computer games. With computer games rapidly shifting to online sales, GameStop appeared destined for the same fate as Tower Records and Blockbuster.
The hedge funds bet that the share price would fall by selling the stock short. To do so they must borrow stock from a brokerage to deliver to the new buyer. If the stock price falls, they can purchase the stock on the market to repay the lender and pocket the difference as profit. However, if the price goes up at some point, they must purchase the stock to repay their loan. Meanwhile they must post cash to secure the loan. In theory, any short seller may experience enormous losses when they ultimately close the transaction if the share price increases.
The flash mob on Reddit noticed the short positions and decided to get rich while punishing the hedge funds by buying the stock. As they piled on they drove the price of the stock up accumulating paper profits for themselves and forcing the hedge funds to purchase shares to close their transaction. The hedge fund purchases further drove up the price of the stock. This whole chain of events is the dreaded “short squeeze”.
In this game, no one really cares what the company is worth. That’s irrelevant. They are playing a dangerous speculator’s game. In the end, a few fortunate players will sell at the highs and enrich themselves, but most players post losses as players unwind their positions and the stock returns to something close to fair market value.
Short sales are a very high-risk speculation much more likely to end in tears than cheers.
While the Reddit flash mob got most of the attention, it appears that other institutions also piled on.
Wall Street’s cops are trying to figure whether this was a criminal conspiracy to drive market prices or something less sinister. Questions remain about the role of one or more of the online brokerages that limited trading at the height of the frenzy to protect their own capital position.
In any event, the flash mob’s attention turned to silver, the event caught the regulator’s and legislator’s attention, found AOC and Ted Cruz on the same side of an issue, but otherwise receded into a historical curiosity.