Under the right circumstances, a group of shit disturbers (domestically or foreign) collude to go after a particular set of stocks; they spook the market. People begin to question what’s real and what’s not in the market, taking money out of the market en mass so as not to have their retirements fucked.
I’m not predicting this will happen, only that I could see it as a possibility.
I won’t say it’s a zero possibility but I feel it’s a remote one.
This situation didn’t arise spontaneously. It happened because Melvin Capital and a few other hedge funds put themselves in a very precarious position. They were shorting the entire supply of one company’s stock, which meant they were placing the obligation upon themselves to buy all of the company’s stock in the future. People saw that and realized they could put the hedge funds over a barrel; they could drive the share price up to ridiculous prices and the hedge funds would have to pay it.
That’s not something that’s going to happen on a regular basis. It’s true you can run the share price of a company up to ridiculous heights by buying it. But in most cases, you’d just be hurting yourself; nobody would want to buy those shares at those artificially high prices. And absent a short selling situation, nobody would have to buy any shares.
And most companies wouldn’t have gone so deeply into this stock. If they had only shorted a tenth of the company’s shares, they would have some leverage. They could tell the people who bought up the shares and drove the price up that they only needed to buy shares from ten percent of them. The other ninety percent would be stuck with shares they had paid a lot of money for but nobody wanted to buy. Once that sank in, people would start racing to lower their prices and be among the ten percent who were able to cash out.
Sort of like encouraging people that the market was crashing and the whole world was doomed when the stock market dip of March occurred? Ultimately, there is no preventing people from acting stupidly unless we are willing to entrust the state with total power. I don’t think that is a better scenario then letting people have liberty and to live with the consequences of said liberty.
Ultimately, folks need to realize that the financial markets aren’t real wealth. They just are a market to trade abstractions that can be exchanged for other abstractions which can be exchanged for real goods and services. The real strength of an economy is the set of goods and services produced not the aggregate nominal value in terms of an arbitrary currency. So, as long as people understand that on average financial metrics shouldn’t deviate too greatly from the underlying fundamentals it shouldn’t be a problem.
What needs to be done, if anything, is not let regulatory capture happen. It’s not right that the big players set the rules and exploit the rules and then when they get beat at their own game change the rules and/or get bailed out. That highlights a broken system where risks are socialized while the elites reap the rewards. Maybe the occupy wall street folks had a point.
Just want to pop in and say this is an excellent, well thought out post.
The real economy vs the financial economy. The problem is that resources that go into the financial economy, don’t go into the real economy. And I feel that currently we’re giving too many incentives to choosing investments in the financial economy.
It’s a decent way to save money for the long term though. How else can we encourage people to save money where it preserves purchasing power and actually can grow as the economy grows?
I do agree that our system does seem to provide some perverse incentives with regards to finance vs real productivity. I’m not sure how to fix that without each citizen having some form of birthright equity or something.
I feel investing in the real economy provides more of these benefits. If I have a million dollars and invest it in a business that’s starting up, then the result of my investment is there’s a new business. That business will be hiring employees and producing goods or services.
If I had taken my million dollars and invested it in the financial economy, where are the benefits to the overall economy? I did something like buy shares in a company that already existed and then sold those shares to somebody else. Or commodity futures or currency exchange. My investment was basically buying something at one price and then selling it when the price was different. I may make money but nothing new was added to the economy.
I feel we should be offering incentives to encourage people to do more of the first kind of investing and less of the second.
Quite a few times, over the last few days, I’ve remembered (former Fed Chairman) Alan Greenspan’s use of the term Irrational Exuberance to describe overheated markets (ie, bubbles). He first used it in the mid-90’s to address the dot-com bubble.
And Robert Shiller’s book that:
analyzes the broader stock market boom that lasted from 1982 through the dotcom years.
But the very well-heeled, and either very savvy or well-connected, make heaps of cash when the hoi polloi are profiting handsomely and when Americans of modest means are having their houses taken from them.
The vast majority of us have truly become erstwhile playthings for those at the very top strata.
As always: the greedy and the ignorant.
#Murica
Yes, overall the stock market is artificial, but it works as long as there is confidence in it.
Lord knows I am not a financial genius. I don’t understand why selling short 140% of a stock is even allowed. If you need permission from the actual holder, 1. why would they let you lower their worth? 2. how can they sell the same holding twice?
I have to disagree with this part. I know why, but it’s not fair that I (as an example) enter Congress so my brother and sister can’t invest their money their own way, either.
It’s generally not an individual holder who loans you the stock.
A brokerage firm has thousands of clients, each with a bit of GME. That means that the brokerage has lots of GME sitting there in their client’s accounts. Stock is fungible, one common share is the same as another common share, so if someone comes by and wants to borrow some, they’ve got a bunch just sitting there.
So, I ask a brokerage to loan me some GME, but I’m not holding it myself, obviously, I sell it to someone else. Now it’s sitting in another brokerage, where it can be borrowed by someone else.
The reason that a brokerage would let you do this is because you have to pay to borrow that share.
Just short selling alone doesn’t lower the worth of a stock. There may be second order effects that do, and it may be part of an investment strategy to lower the value of a stock, but the short sale in and of itself doesn’t really lower its worth. All things being equal, you are able to make more from the premium than you would lose in value.
I don’t disagree with that, but there should be severe penalties to you and your family if they trade on any information that you share, or if you manipulate things in their favor.
Could you give the name of this book? (The search function on this forum is kind of broken. I could search for the author, but he undoubtedly has published many books.)
Is the well-heeled quote from that book?
We both agree on this, and it’s sad that said punishment rarely occurs.
It was in the linked article, but … of course:
Nope. That one’s mine.
If the clients fail to deliver, the brokers are on the hook to fulfill the obligations. If the brokers also fail to deliver, insurance takes over (SIPC plus whatever supplemental insurance the brokers may or may not have). If insurance can’t pay up… well, that’s a financial crisis.
Okay, that covers what happens to the people who loaned the stock.
But what about the reddit investors? It seems some of them are in this to destroy Melvin Capital while others are in this to make money. And some of them are probably in this for both reasons.
It seems to me these two goals are irreconcilable. The people who want to make money need Melvin Capital to still be around in order to pay them for the shares they’ve bought.
Is there a realistic scenario in which the hedge companies are destroyed but the online investors still make a profit?
That seems like a very indirect path to investing in the real economy. If you want to invest in the real economy, just do it. Don’t invest in the financial economy so you can later take your money out of the financial economy and invest it in the real economy. Time, after all, is the one of the resources you’re investing.
And you highlight the main reason that the stock market has been going up so much in the last few years. Why it has exploded during a pandemic that by all common sense should have seen it retract significantly.
People are not investing in small businesses as much. It’s not that they don’t want to, it’s that those opportunities are dwindling.
As a small business owner with a successful business, one that is actually managing to do pretty well through this pandemic, my bank if falling over itself trying to get me to borrow more and more money. They are sitting on a ton of liquidity, and not nearly enough qualified borrowers.
I more or less cashed out my 401k as part of opening my business, along with some other small investments I had made over the years. In theory, other people who have been growing their wealth in the stock market could do the same thing, but this is not a good time to open a business.
I do wonder what’s going to happen when the pandemic comes to an end, and people look around at all the vacant properties, and decide to try opening up their own shop again. If we have a reasonable healthcare plan that doesn’t punish small businesses, that would also encourage such action.
However, if you do have millions of people suddenly pull out their investments from the stock market to open their own business, I wonder if that will be what bursts the current bubble, crashing it.
Under the right circumstances, a group of shit disturbers (domestically or foreign) collude to go after a particular set of stocks; they spook the market.
And how is that a bad thing? If it tamps down a market that seems to exist as a series of bubbles, that’s a good thing. Perhaps people should be spooked by a market that is clearly in bubble territory.
I like this short squeeze because it is market-based regulation. This can’t happen to rational investors basing their decisions on corporate fundamentals, or hedge funds that don’t do extreme things like short 140% of the stock such that it becomes impossible to cover their positions if they get squeezed.
Global finance is a complex system. Complex systems regulate themselves through feedback. Connected financial firms always have an incentive to manipulate the system to eliminate the feedbacks that limit their profits. That’s when you get imbalances, misallocation of capital, etc.
If institutional traders now have to worry about being squeezed if they try to manipulate the market, then their decisions are being regulated - just not by government.
Let me give you an example from the world of betting. There are gamblers out there who look for ‘middles’, or differences between odds at various bookmakers great enough that the bettor can make a bet on both sides of a gamble and guarantee a profit. And if they can guarantee a profit, they can bet everything they have on it.
Bookmakers hate middlers, and would love to see them regulated. But middlers keep the bookmakers honest. For example, a bookmaker might find that when the home team is playing, they can take advantage of people and offer worse odds on the home team, knowing that the homies will take the bet anyway. But with middlers in the picture, they have to offer the same odds as the bookies in the other home city, or risk getting killed by the middlers. So gambling odds tend to be as close to the real odds as the bookmakers can discern. The ‘shady’ middlers keep them honest.
In stocks the same is true. Hedge funds are necessary to keep down irrational exuberance and to help free money from low productivity uses to higher ones. They may be bottom feeders, but every ecosystem needs them to recycle dead material back into the system.
If Gamestop is a dead idea, then the faster it dies the better it is for the economy as a whole. Hedge funds force some reality into the situation. But then you have the problem of the hedge funds maximizing profits by going too far themselves. And until now, they’ve continued this imbalance primarily through regulatory capture, so they didn’t face the negative feedback market excesses should face.
So now they are being regulated. Not by government, but by r/wallstreetbets. It’s the market in action, doing what it should. It’s only the people benefiting from the regulatory capture that are screaming about this. Unfortuntely, they will problably win, and we’ll see new financial regulations that protect the insiders from the masses, billed as a way to protect the masses from the complexities of stock investing.
It goes up a chain. Redditor buys GME stock through broker Robinhood. Robinhood’s owner Citadel actually does the buy/sell work and takes a little bit from Robinhood for the service and makes money. Citadel also owns Melvin. Melvin overextends, Citadel has to shove money into Melvin to cover their ass so Citadel doesn’t go under after paying Robinhood to pay the Redditor. Citadel is in turn funded by one of the BIG banks like JP Morgan Chase or Goldman Sachs or Morgan Stanley, who make money when Citadel makes money and are likewise on the hook if Citadel fucks up, say like having to shovel 3BN into Melvin and another billion into Robinhood to keep things going.
It helps to remember that at any given time, due to lax regulatory standards, most of these financial entities have nowhere NEAR the liquid capital necessary to cover their asses in the event some random bunch of internet weirdos decides to play their reindeer games–randos who do NOT have that kind of skin in the game. A million internet weirdos who each have maybe a grand of real money each invested, say, who then drive up the price of a stock into the stratosphere then every one of whom says “give me my money, you fat fucks” means some very big players suddenly have to actually dip into their pockets, sell other stuff they were saving for later and in general it upsets the holy fuck out of the comfortable little shell game they’ve devised for their own enrichment.
And if at any time it occurs that when the randos demand their money after hedge funds fuck up a naked short and there ISN’T money available to pay the randos then the entire thing comes to a grinding halt, a liquidity crisis occurs and the shell game can’t resume until the randos are satisfied. All that money then goes OUT of the shell game and can’t be used by the big fucks unless the randos decide to put it all back in–but randos do weird shit like, y’know, pay bills and medical debt and settle their student loans and pay off the mortgage on their mom’s house so they can continue to live in the basement and from the standpoint of Goldman Sachs that money is effectively GONE for a good long while, which makes the shell game less fun and the big fucks get cranky. To which I say, suck it, fat fucks. Starve the rat and you’ll find him biting your feet in bed one day. They’ve been starving us for decades with this bullshit and now the bill is come due. Too bad, SO sad. ¯\_(ツ)_/¯