Game Stop Ain’t The Only
One!
We’ve seen a
lot of “news” and or commentary recently on the Game Stop stock fiasco (details
on the specifics later). It seems it’s more newsworthy when a group of non-Wall
Street types hype a stock to artificially drive stock prices up. What floored
me were several commentaries on the possible effects of these events on hedge funds.
I say this because the implication was that the noble hedge funds are worthy of
our sympathies and respect.
We should
seriously consider renaming the NYSE “Vegas On Wall Street” if current shenanigans
continue or are allowed to. The proliferation of hedge funds has done several
things, all based on the manipulation of financial instruments several light
years removed from just “money” or share values as a reflection of a
corporation’s actual value. Of course, history teacher that I am, here’s some
background, not on hedge funds which are late 1940s inventions but on investors and “bubbles.”
Tulipmania,
which swept Holland in the 1630s is one of the earliest recorded instances of
an irrational asset bubble. During the Dutch Tulip Bubble, tulip prices soared
twentyfold between `November 1636 and February 1637 before plunging 99% by May
1637. Invest 100 guilders in 1636, see it become 1 guilder a year later! As
bubbles typically do, Tulipmania consumed a wide cross-section of the Dutch
population, and at its peak, some tulip bulbs commanded prices greater than the
price of some houses!
The UK South
Sea Bubble of 1720 was created by somewhat more complex circumstances than
Tulipmania. The South Sea Company, in 1711, was promised a monopoly by the
British government on all trade with the Spanish colonies of South America.
Expecting a repeat of the success of the East India Company, which provided
England a flourishing trade with India, investors snapped up shares of the
South Sea Company. While directors circulated tall tales of unimaginable riches
in the South Seas (lied), shares of the company surged in 1720, from £128 in
January to £1050 in June, before collapsing in subsequent months and causing a
severe economic crisis.
Far more
current was the Dotcom bubble: When it comes to sheer scale and size, few
bubbles match the dotcom bubble of the 1990s. Rapidly increasing popularity of
the Internet triggered a massive wave of speculation in "new economy"
businesses. As a result, hundreds of dotcom companies achieved multi-billion-dollar
valuations as soon as they went public. (no tangible product, no
customers, just “code.” Technology/dot-com company stocks, went from a level of
under 500 at the beginning of 1990 to a peak of over 5,000 in March 2000.8 The index crashed shortly
thereafter, dropping nearly 80% by October 2002 and triggering a U.S.
recession.
The Great
Depression was based on the myth that everyone should be in the stock market and
that their investments were safe. Brokers were only too happy to borrow from
banks and “re-lend” to investors for stock purchases. The hyping of stocks helped
drive process far beyond actual asset value and eventually, even in the face of
Presidential assurances that things were fine, someone, somewhere, thought, “Maybe
these share prices aren’t really based on true monetary value. Perhaps I should
sell before anyone else figures it out.” Unfortunately for many (and their banks)
that notion spread with light speed and the world spiraled into a depression
lasting a decade.
As a result, in
the US, banking regulations were tightened with the Glass-Steagall Banking of
193. All US banks had been allowed to use depositor’s funds without limitations
or oversight, losing millions for depositors who had never played the market. Glass-Steagall effectively separated commercial banking
from investment banking and created the Federal Deposit Insurance Corporation,
among other things.
Glass-Steagall
was “eroded” over the course of several decades, the intended clear-cut
separation between commercial and investment activities gradually deteriorated.
Multiple factors contributed to this effect, including market forces, statutory
changes, and the exploitation of regulatory loopholes. Unmentioned is a much simpler
factor – greed. Some of these erosions of the Act’s intent had much to do with market
tactics leading to 2008 Housing Bubble collapse.
The 2008 fiasco
has been exhaustively covered, but in simplest terms it boils down to “securities,
or financial instruments, whose real value was far below advertised and whose
risk of default was grossly underplayed until it happened.” Added to the mix
was the rise of hedge funds which in some eases bet on stocks to fail, vice
prosper. The rub here is that shares prices in these funds are so fluid that, on
any given day, value and price are just words, not synonyms. “Hedge fund” is simply another name for an
investment partnership that has freer rein to invest aggressively and in a
wider variety of financial products than mutual funds.
Mutual fund
managers analyze stocks for value and growth potential and investors, many of
them state/municipal/union retirement funds expect growth in their share values
which may be widely varied to decrease risk. On the other hand, Hedge funds
also use far riskier tactics such as “short selling” and investment in much riskier
securities (such as the high-risk overrated mortgages which led to the Great Recession
in 2008.
Following the events
of 2008, Congress took another shot at reining in unregulated greed with the
Dodd-Frank Act, whose stated aim was to “Promote the financial stability of
the United States by improving accountability and transparency in the financial
system, to end "too big to fail", to protect the American taxpayer by
ending bailouts, to protect consumers from abusive financial services
practices, and for other purposes.” It is noteworthy that, from his first day
in office, Donald Trump, himself and his businesses heavily leveraged (in debt),
worked to erode the authority and reach of the act. One hopes the Biden administration
will remedy these issues.
So, what
happened with Game Stop? Game Stop is a “brick and mortar” (real stores) purveyor of video games and related accessories.
It was struggling through the pandemic, and the outlook for continued operation
nationwide was declining. Normally, in this situation, stock prices would
decrease and, eventually lead to going out of business. This was true of not only
Game Stop, but AMC theaters, Blackberry and Nokia.
In such
situations, where share prices are dropping and predicted to continue doing so,
hedge funds, like vultures, flock to the corpse. This is part of the hedge fund
tactic of profiting from the misfortune of others. In the case of Game Stop, it
was the tactic of short-selling which, in simplest terms, means that, once the
fund manager(s) decide a stock will continue to decline in price, they may “borrow”
shares of that stock on the premise that they will return them at some time certain.
You can ‘short’ a position in the stock market, which means selling something
that you do not own, but then you must ‘close’ that position also, which means
buying that same position back at a later time.
In a simple
example: assume a trader believes Game Stop is overvalued at (just for a simple
example) $50 per share. He may “borrow” 100 shares from a broker, who may then
sell them for him at the current price – a $5,000 transaction. The investor
must repay the shares to the lender, not
the money. In the ensuing (days/weeks) the share price drops to $25. The investor’s
due date for repayment to the broker arrives, but he only has to deliver 100 shares
of Game Stop, so he buys them at the new lower price of $2500 and pockets the
$2500 difference as profit.
Short selling a
stock is riskier than traditional investing. With traditional investing, there
is a limit to how much someone can lose, that being the value of the original
investment. With short selling, there is no limit to how much money someone
could lose, as there is no limit to how much a stock could appreciate. With Game
Stop, which does have fans who want them to remain in business, and via a Reddit investor
“group,” individuals began buying Game Stop which was already being “shorted” by
a number of hedge funds. And so, these gamers and people on social media said,
‘Hey, we’re going to revolt. We’re going to start buying this stock.’ And so,
when GameStop stock started to rise, all of these short sellers (Hedge Funds) had
no choice but to buy at higher prices. When the short sellers were forced to
buy the stock at higher prices, it exacerbated the situation because then the
stock price rose even more. As the demand for the stock went up, so, naturally
did the share price…a lot!
GameStop was selling
at $12.72 on December 11, last year, but by January 27th was trading
at $347.51!! Did they open new stores? Nope. Introduce new products? Nope. Will
the price remain that high? Nope. Game Stop closed Friday at $63.77, a decrease
from its high of 545%. Meanwhile young gamers, some of whom invested their parents’
retirement in Game Stop, are crushed. The good news (if any)? Hedge funds which shorted game stop took a
billions of dollars bath. As they unloaded during the run up, being forced to
repay borrowed stocks at ten times or more per share, depending on how high
their threshold of pain is, they affirmed the fragile and increasingly volatile
nature of playing with other peoples’ money. Meanwhile hedge fund managers reap
multi-millions annually, risking little or none if their own money. Yet when a
Liz Warren calls for more stringent controls on financial markets??
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