Continuing on the coordinated reddit army of investor’s attack on hedge funds shorting Gamestop, Sinan Aral of MIT has some observations on the situation in WaPo that rings bells for me. For example, the fact that a crowd can be heterogenuous:
The Securities and Exchange Commission said Friday it is reviewing the recent volatility in GameStop and other stocks. Good. Not nearly enough is known about the perverse incentives and feedback loops driving these market movements. For example, who is in this “crowd”?
And were the individual investors hapless dups of other corporate entities?
And what role has been played by hedge funds standing to profit from the dizzying price increase? Yes, some hedge funds were short-squeezed and lost a fortune, but other institutions — such as BlackRock, owning 9 million shares of GameStop — likely made more than $1 billion on the madness.
But most importantly is a point I’ve been trying to make:
There are also perverse incentives created by Robinhood and other retail investing sites that purport to give the little guy a seat at the Wall Street table, but that actually earn large swaths of their revenue from institutional investors by processing trades through market makers, including Citadel Securities, that provide the other end to the trade. …
Perhaps most important, if social media can disrupt markets, it creates an incentive for economic terrorism and provides an opening for America’s enemies. If Russia saw an opportunity to disrupt U.S. elections with disinformation on social media, imagine what Moscow must be thinking about the prospects for interfering with the U.S. economy. The results of the SEC’s GameStop review cannot come fast enough.
Much like a discussion about anonymous participants in news and discussions in which we cannot know the true motivations of the participants with any certainty that I had long ago on UMB, the motivations of the players in this game – especially those with greater leverage, whether financial or communications-related – are not certain. Profit without ethics? Damage to institutional entities such as the hedge funds? Maybe the next shot will be to take down an important financial institution, such as Bank of America? Or a defense contractor?
Was this a test run?
But this paragraph reminded me that a lot of pundits are ignoring an important distinction between pump ‘n dumpers and this incident:
But what has transpired lately with the stocks of GameStop, the AMC movie theater chain and the BlackBerry tech company breaks fresh ground. The problem is that the world is witnessing this plane crash in real time: Right now, the plane is still at 30,000 feet, but countless small investors could be wiped out when the inevitable crash comes — when the market tries to find the appropriate prices for stocks that are untethered to companies’ underlying value.
A pump ‘n dump has the same characteristics that Aral & other observers assume they’re seeing here: a sudden and unjustified jump in price motivated by one category of investor, the dishonest pumper, and brought to fruition by the second category of mislead investors who put money into a misperceived opportunity, followed by the perpetrators dumping the stock for profit, and the long ride down to low prices for those who bought at the top.
But in the Gamestop incident we have a third player: the victim hedge fund, Melvin Capital. Because the short squeeze means they are being forced to buy shares of stock at higher and higher prices, far higher than they originally sold their borrowed stock for, this means a vast injection of cash into the financial web surrounding the Gamestop stock[1] is occurring. This may mean that the small investors are not as vulnerable to being wiped out as they would in a pump ‘n dump situation. I would guess the reddit army will come away with vast profits, derived from Melvin Capital’s requisite buying of shares on the open market. Naive investors who went where the action is may, on the other hand, suffer significant losses when the Gamestop share price settles down to more reasonable levels.
If it does. As I noted in my previous post on this thread, Gamestop’s new board members may be able to convert the company into an online entity that is capable of generating the profits necessary to keep the share price high. That remains to be seen.
Speaking of the naive investor, a reader writes about his naivete:
I played the short game in the past. I think it’s akin to riverboat gambling. A $30,000 one-week loss convinced me that is not a game I will play again. It was an expensive lesson.
I considered playing some shorts. I ran an informal experiment and decided I was not equipped to be successful, and so I never plunged in. However, I did a bit of, oh, month trading for a short while. The first two trades made some money. The third was another story, which, come to think of it, I still own after all these years. I’m surprised the company is even still around. No more of that, I say. Long term investing means not having heart burn, not paying fees like mad, and occasionally getting lovely surprises.
Ya gotta like it.
1 If Gamestop is holding any of its own stock in its treasury and sells it at this time, it also benefits from an unexpected cash injection. Whether they do, did, or not, I do not know.
