In a blowout comedy for the ages, finance pirates take it up the clacker
In the fall of 2008, America’s wealthiest companies were in a pickle. Short-selling hedge funds, smelling blood as the global economy cratered, loaded up with bets against finance stocks, pouring downward pressure on teetering, hyper-leveraged firms like Morgan Stanley and Citigroup. The free-market purists at the banks begged the government to stop the music, and when the S.E.C. complied with a ban on financial short sales, conventional wisdom let out a cheer.
At the time, poor beleaguered banks were victims, while hedge funds betting them down as the economy circled the drain were seen as antisocial monsters. “They are like looters after a hurricane,” seethed Andrew Cuomo, then-Attorney General of New York State, who “promised to intensify investigations into short selling abuses.” Senator John McCain, in the home stretch of his eventual landslide loss to Barack Obama, added that S.E.C. chairman Christopher Cox had “betrayed the public’s trust” by allowing “speculators and hedge funds” to “turn our markets into a casino.”
Fast forward thirteen years. The day-trading followers of a two-million-subscriber Reddit forum called “wallstreetbets” somewhat randomly decide to keep short-sellers from laying waste to a brick-and-mortar retail video game company called GameStop, betting it up in defiance of the Street. Worth just $6 four months ago, the stock went from $18.36 on the afternoon of the Capitol riot, to $43.03 on the 21st two weeks later, to $147.98 this past Tuesday the 26th, to an incredible $347.51 at the close of the next day, January 27th.
The rally sent crushing losses at short-selling hedge funds like Melvin Capital, which was forced to close out its position at a cost of nearly $3 billion. Just like 2008, down-bettors got smashed, only this time, there were no quotes from economists celebrating the “good news” that shorts had to cover. Instead, polite society was united in its horror at the spectacle of amateur gamblers doing to hotshot finance professionals what those market pros routinely do to everyone else. If you’ve ever seen Animal House, you understand the sentiment:
The press conveyed panic and moral disgust. “I didn’t realize it was this cultlike,” said short-seller Andrew Left of Citron Research, without irony denouncing the campaign against firms like his as “just a get rich quick scheme.” Massachusetts Secretary of State Bill Galvin said the Redditor campaign had “no basis in reality,” while Dr. Michael Burry, the hedge funder whose bets against subprime mortgages were lionized in “The Big Short,” called the amateur squeeze “unnatural, insane, and dangerous.”
The episode prompted calls to regulate Reddit and, finally, halt action on the disputed stocks. As I write this, word has come out that platforms like Robinhood and TD Ameritrade are curbing trading in GameStop and several other companies, including Nokia and AMC Entertainment holdings.
Meaning: just like 2008, trading was shut down to save the hides of erstwhile high priests of “creative destruction.” Also just like 2008, there are calls for the government to investigate the people deemed responsible for unapproved market losses.
The acting head of the SEC said the agency was “monitoring” the situation, while the former head of its office of Internet enforcement, John Stark, said, “I can’t imagine there isn’t an open investigation and probably a formal order to find out who’s on these message boards.” Georgetown finance professor James Angel lamented, “it’s going to be hard for the SEC to find blatant manipulation,” but they “owe it to look.” The Washington Post elaborated:
To establish manipulation that runs afoul of securities laws, Angel said regulators would need to prove traders engaged in “an intentional act to push a price away from its fundamental value to seek a profit.” In market parlance, this is typically known as a pump-and-dump scheme…
Even Nancy Pelosi, when asked about “manipulation” and “what’s going on on Wall Street right now,” said “we’ll all be reviewing it,” as if it were the business of congress to worry about a bunch of day traders cashing in for once.
The only thing “dangerous” about a gang of Reddit investors blowing up hedge funds is that some of us reading about it might die of laughter. That bit about investigating this as a “pump and dump scheme” to push prices away from their “fundamental value” is particularly hilarious. What does the Washington Post think the entire stock market is, in the bailout age?
America’s banks just had maybe their best year ever, raking in $125 billion in underwriting fees at a time when the rest of the country is dealing with record unemployment, thanks entirely to massive Federal Reserve intervention that turned a crash into a boom. Who thinks the “fundamental value” of most stocks would be this high, absent the Fed’s Atlas-like support in the last year?
For context, Goldman, Sachs posted revenues of $44.56 billion in 2020, its best year since 2009, a.k.a. the last year Wall Street cashed in on a bailout. Back then, the shortcut back to giganto-bonuses was underwriting fees for financial companies raising money to purge themselves of TARP debt. This time it’s underwriting fees for bond issues and IPOs. The subtext of both bailouts was that anyone who owned or underwrote financial assets got richer, while everyone else got the proverbial high hat. It’s no accident that income inequality dramatically accelerated after the last bailouts, and that the only people to see net gains in wealth since 2008 have been the richest 20% of Americans, a pattern almost certain to continue.
The constant in the bailout years has been a battery of artificial stimulants sent through the financial sector, from the TARP to years of zero-interest-rate policies (ZIRP) to outright interventions like the multiple trillion-dollar rounds of Quantitative Easing. All that froth allowed finance companies to suck out hundreds of billions in fees, encouraged lunatic risk-taking in every direction and rampages of private equity takeovers, and kept a vast stable of functionally dead companies alive on cheap credit.
Those so-called “zombie companies” make up roughly 30% of all corporations in America now, and they racked up over a trillion dollars in new debt since the pandemic alone. While policymakers may have stabilized the economy with the bailouts, they may also “inadvertently be directing the flow of capital to unproductive firms,” as Bloomberg euphemistically put it back in November.
In other words, it was all well and good for investment banks and executives of phoney-baloney companies to gorge themselves on funhouse profits on a funhouse economy, but when amateurs decided to funnel just a bit of this clown show into their own pockets, finance pros wailed like the grave of Adam Smith had been danced upon. The worst was Morgan Stanley CEO James Gorman, who issued a somber warning that those behind the recent market frenzy are “in for a very rude awakening,” adding, “I don’t know if it is going to happen tomorrow, next week or in a month, but it will happen.”
This is the same James Gorman whose company just saw its 2020 fourth-quarter profits go up 51% versus the year before, with total revenues up 16% to $48.2 billion, matching almost exactly the 16% rise in the stock market last year. If you’re going to rake in $33 million as Gorman did last year captaining a firm that just siphoned off billions in essentially risk-free profits underwriting a never-ending bailout, should you really be worrying about someone else getting a “rude awakening”? There are 19 million people collecting unemployment who might be reading those profit numbers. Does this man know how to spell “pitchfork”?
GameStop has prompted more pearl-clutching than any news story in recent memory. Expert after grave-faced expert has marched on TV to tell Reddit traders that markets are complicated, this isn’t a game, and they wouldn’t be doing this, if they really understood how things work.
“I’m not sure everybody fully understands what’s happening here,” was the melancholy comment on CNBC of Wall Street’s famed fluffer-in-chief, Andrew Ross Sorkin. The author of Too Big to Fail added in pedagogic tones that while this “stick it to the man moment” might feel good, betting up the value of GameStop above Delta Airlines just isn’t right, because “there are no fundamentals here”:
Fundamentals? How much does Sorkin think his exalted Delta Airlines would be worth now, if the Fed hadn’t stopped its death plunge last March? How much would any of the airlines be worth in the Covid age, with their fleets of mothballed jets? What a joke!
Furthermore, everybody “understands” what happened with GameStop. Unlike some other Wall Street stories, this one isn’t complicated. The entire tale, in a nutshell, goes like this. One group of gamblers announced, “Fuck you!” Another group announced back: “No, fuck YOU!”
That’s it. Or, as one market analyst put it to me this morning, “A bunch of guys made a bet, got killed, then doubled and tripled down and got killed even more.”
Regarding improprieties, leaving aside that the Redditors were doing exactly what billion-dollar hedge funds do every day — colluding to move a stock for fun and profit — the notion that this should be the subject of a federal investigation is preposterous.
Is it completely outside the realm of possibility that the GME fiasco isn’t just day traders giving the finger to Wall Street, that “major players” are behind the stock’s movement, in an illegal manipulation scheme? No. Probably it’s not that, but it could be, just as some of the usual suspects may have piled on the long side once the frenzy started. But if there’s anything to investigate here, the obvious place to start is with the hedge funds and their brokers.
While it isn’t a complicated story, some of the awesome humor of GameStop is in the mechanics.
Unlike betting on a stock to go up (i.e. betting “long”), where you can only lose as much as you invest, the losses in shorting can be infinite. This adds a potential extra layer of Schadenfreude to the plight of the happy hedge fund pirate who might have borrowed gazillions of GameStop shares at five or ten hoping to tank the firm, only to go in pucker mode as Internet hordes drive the cost of the trade to ten, twenty, fifty times their original investment.
Short-sellers bet by borrowing shares from so-called prime brokers (Goldman, Sachs and JP Morgan Chase are among the biggest), selling them, and waiting for the price to drop, at which point they buy them back on the open market at the lower price and return them. The commonly understood rub is that prime brokers don’t always really procure those original borrowed shares, and often give out more “locates” than they should, putting more shares in circulation than actually exist (as in this case). GameStop is exposing this systematic plundering of firms using phantom shares and locates, by groups of actors who now have the gall to complain that they’re the victims of a “get rich quick” scheme.
Short-sellers are not inherently antisocial. They can be beneficial to society, instrumental in rooting out corruption and waste in whole sectors like the subprime industry, or in single companies like Enron. Moreover, the wiping out of such funds isn’t necessarily to be cheered. Sorkin correctly notes that many hedge funds invest on behalf of entities like pension funds, though maybe they shouldn’t, given their high cost and relatively mediocre performance, as I’ve noted before.
However, that’s the point. The degree to which even the beneficial functions of short-sellers are cheered or not is dependent upon whose corruption they’re uncovering. Let the record show that when the S.E.C. imposed a ban on shorts of financial stocks in 2008, they routed short-sellers who were dead right about the insolubility of America’s banking sector. The state prevented their correct judgment about companies like Wachovia and Washington Mutual, whose stocks kept plunging even after the ban and went bust soon after.
The shorts were right about all the other banks, too. The Inspector General of the TARP, Neil Barofsky, eventually told the Financial Crisis Inquiry Commission that 12 of the 13 biggest banks were on the brink of failure when they got saved — by the short ban, by emergency overnight grants of commercial bank licenses to companies that weren’t commercial banks, by the bailouts, by the subsequent avalanche of underwriting fees, and most of all, by the lies about all of the above.
The home of James “rude awakening” Gorman, Morgan Stanley, got its bank holding company license (and the lifesaving Fed credit lines that came with it) late on a Sunday night in September, 2008, because the firm couldn’t have opened its doors without it the next Monday morning. They’d have been blown to bits, by “fundamentals.” Instead, they got rescued, given a forever pass to keep feeding at the neck of society while claiming, falsely, to be not-failures and not-welfare recipients, better somehow than the “dumb money” they think should be theirs alone to manage.
The rank selectivity of this makes any moral argument against the GameStop revolt moot. There’s no legitimate cause here, just an assertion of exclusive rights to plunder, which will doubtless be exercised now in the form of bans, investigations, and increased barriers to market entry. Probably also, in the political spirit of our times, there will some form of speech crackdown on platforms like Reddit, to protect us from the mob.
About that: there are many making hay of a description found on a Subreddit, to the effect that wallstreetbets is “like 4Chan found a Bloomberg terminal.” A columnist at the Guardian, settling into the rhetorical line sure to find acceptance among the wine-and-MSNBC crowd, admitted to finding the rampaging-id dynamic on 4chan funny as a young person, but strange now to “witness a brief and regretful adolescent occupation re-emerge as a prominent cultural force.” The author wanted to admit to laughing at this “intentionally senseless” behavior, but ultimately decried the “transgressive attitudes” of the Redditors.
This is where society will ultimately come down, of course, uniting to denounce $GME as financial Trumpism, even though it actually comes closer to being an updated and superior version of Occupy Wall Street. It’s likely not any evil manipulation scheme, but ordinary people acting — out of self-interest, but also out of sheer enthusiasm for one of the best reasons to do just about anything, because you can — on a few simple, powerful observations.
They’ve seen first that our markets are basically fake, set up to artificially accelerate the wealth divide, and not in their favor. Secondly they see that the stock market, like the ballot box, remains one of the only places where sheer numbers still matter more than capital or connections. And they’re piling on, and it’s delicious, not so much because they’re right, but because the people running for cover are so wrong, and still can’t admit it.
Buy the ticket, take the ride, nitwits. If you earned anything, it’s this.