The world of high finance is boring and complex at the same time. The result is that those of us who are not part of it are deterred from understanding and examining what is going on. We switch off when confronted with the technical terms and complex financial instruments we occasionally hear about when it leaks out into the mainstream media. They are opaque. Too difficult to understand and certainly off limits to any but the few professional practitioners who understand. If something is opaque you can’t see through it and that is what they want. But the financial sector is not separate from the real world and it affects our lives. For those of us lucky enough to have a pension they are playing with our money. In the financial crash of 2008, ordinary people lost their savings while the institutions were bailed out by the government. The next crash will be even larger and more destructive. The latest financial story, the short selling of shares in GameStop, has exposed the fragility of the financial sector within the capitalist system.
In April 2017 Ryan Cohen sold Chewy, his online pet food business. He now had $3.5 billion to play with. Last year he acquired shares in GameStop, a retail provider of video games and consoles. Having bought quite a lot of shares he started to tell them how to run their company. He told them they needed to make changes; close a lot of stores, and move online (it had worked for dog food). Other investors, expecting things would improve, started to buy the stock. By the end of November the price had tripled. Hedge funds, in particular Melvin Capital Management and Citron Research, saw this happening and believed the stock was now overvalued. They started to short GameStop. (You might like to break off and read the below explanation of short selling). As a result the price went down. But the `hedgies’ didn’t close out their positions when the price fell, they held on for it to go down even more.
DeepFuckingValue is the user name of Keith Gill. Also known as Roaring Kitty. This amateur trader, noticing that hedge fund traders had shorted (borrowed) large amounts of shares in GameStop, did a bit of DD (due diligence) on the company. He realised that GameStop had healthy sales and that the Covid-19 pandemic, with people forced to stay at home, had brought about a surge in computer game use and the purchase of consoles. He bought GameStop stock and shared this information with members of WallStreetBets, an online message board on the social media site Reddit. Because they are not ‘professional’ traders these `amateurs’ are referred to as `retail’ investors. The difference between professional and amateur traders is that the professionals are using other people’s money and the amateurs are using their own. Other retail traders on the forum joined DeepFuckingValue, buying shares in Gamestop. They were going ‘long’, buying in order for the price to go up, against the hedge fund traders who were shorting, making money as the price went down.
There were two reasons that these small investors did this. One, they saw an opportunity to make money on a share that had had its price artificially brought down. Two, they liked the idea of giving the hedge fund traders a bloody nose. The result was that the price of GameStop went up. This horrified the hedge fund traders who stood to make large losses.
The added problem was they were leveraged. They had borrowed in order to increase the amount they were trading. Traders with a million pounds don’t just acquire a million pounds worth of shares, they borrow money to acquire a much larger amount of stock. So they have borrowed ten million pounds worth of stock although they’ve only got a million in hard cash to back it up. If they are short they are going to give the shares back anyway, aren’t they? The worst thing that can happen to you if you are long is that the price goes down to zero and you’ve lost all your money. If you are short and leveraged you lose money as the price goes up and it can keep going up and up so you can lose more than you ventured in the first place.
By late January of this year the overall short position in Gamestop was 68 million shares. The total company’s float is 45 million shares. A reasonable person would ask how could you get to a position where 140% of existing shares were being traded. Remember you have only borrowed shares, they haven’t actually changed hands. The same shares could be lent out more than once. And you can buy a CDF, a Contract for Difference where you don’t own the underlying asset, you’ve just made a contract with someone else to settle up at a later date after the price has moved. It doesn’t matter until everyone wants to close their positions at the same time. On 26 January the stock closed at $145.60, then increased to $345.00 the next day, peaking at $469.42 on 28 January. The hedge funds were forced to close their positions, in other words, buy back the stock in order to return it to the brokers they had borrowed from. Short sellers lost an estimated $23.6 billion on GameStop in this rally. Melvin Capital lost 30 per cent of the $12.5 billion it invested in managing shorted stocks.
There have been cries of `foul play’ from the hedge fund traders and journalists and financial commentators who accuse the WallStreetBets posse of manipulating the markets by colluding to drive up the price of a share. There is talk of the Securities and Exchange Commission (SEC) investigating and DeepFuckingValue has testified to a Congressional Committee. Hedge funds and the like manipulate the markets all the time. Pump and dump is a term which neatly describes what they do. Issue rumours and tips on social media to encourage people to buy a particular stock which they are holding and when they buy and the price goes up they dump their stocks for a profit, sending the price down again. They do the opposite when they are shorting, making statements denigrating the companies to make the price fall. Sheer size also helps. If you already have millions to invest and you can leverage to tens or even hundred of millions, a new factor comes into play. Your massive investment tips the market in your favour. If a lot of people want something it is in demand and the price goes up. How do they get away with it? With the collusion of those who are supposed to be regulating the financial system.
These financial traders do not create any value. They are gambling with our money and with the stability of the economic system. They argue that their financial transactions allow these `instruments’ to find their true value in the market, so they are doing us all a favour by making the market more efficient. Funny, I thought they were in it to make money. The retail traders on WallStreetBets are not class warriors confronting the capitalist system, but they are shining a light on the tactics of the hedge fund traders and making it more difficult for them to manipulate the markets.
You can’t make much profit from a stable asset, it has to be volatile to make money in this way. Risk and volatility are necessary, particularly in a time when interest rates are so low. In the current legal framework none of these things are fraud, they are perfectly legal. Gambling and speculation have always been at the heart of the capitalist system. From the tulip mania in 1637 when a single bulb commanded the same price as a house, to the South Sea bubble in 1720. The rush to make money in this year meant that a proposal `For carrying-on an undertaking of great advantage but no-one to know what it is!!’ attracted £2000 investment. Capitalism is driven to crisis and destruction in order to restore the rate of profit. This behaviour in the world of finance is not an unpleasant side effect, it is a necessary part of the capitalist system.
Richard Roques
Short selling explained: how to sell before you buy
Ms Long has 100 shares of the Jolly Good Company stock worth £10 each. Mr Short thinks it’s a jolly bad company so he goes to a broker who borrows Ms Long’s 100 shares and lends them to Mr Short who pays a small fee to the broker. Mr Short sells the borrowed shares for £1,000. The price drops to £5. Mr Short buys shares for £5 and closes his position by returning the 100 shares making a £500 profit. SOMEONE, SOMEWHERE IN THE MARKET HAS LOST £500. If the price had gone up to £15 he would have had to buy the shares for £1,500 and lost £500 in order to return the shares.
More risks: Mr Short must have a margin account which is collateral backing up his trades. The broker may make a margin call forcing Mr Short to put more money in his account. He may run out of money and be forced to close his position (return the stock) when he doesn’t want to.
