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The Whole Messy, Ridiculous GameStop Saga in One Sentence

The Whole Messy, Ridiculous GameStop Saga in One Sentence

How to understand what the hell is going on this week

If you want it in a sentence, I guess it goes something like this: The GameStop saga is a ludicrous stock mania born of pandemic boredom and FOMO, piggybacking off of a clever Reddit revenge plot, which targeted hedge funds, who made a reckless bet on a struggling retailer—and it’s going to end with lots of people losing incredible amounts of money.

Got that? Maybe not. So let’s start at the beginning.

This week, the sleepy video-game retailer GameStop went on the ride of its life. The company’s stock rocketed from about $40 to almost $400 in a matter of days, minting day-trader millionaires and extinguishing billions of dollars of bets against the firm placed by institutional investors. Then, this morning, GameStop trading was restricted on the Robinhood platform, where more than half of all users hold shares in the company. The stock lost three-quarters of its value in 85 minutes, plunging from nearly $500 at 10 a.m. to $120 at 11:25 a.m.

To see how the whole thing went down, imagine a kind of misshapen nesting-doll set with four characters: GameStop, hedge funders, Reddit traders, and zillions of retail investors.

At the center is GameStop, which is not a great company. In 2019, the strip-mall fixture lost almost $500 million. In 2020, a pandemic forcibly shut down many of its stores and gutted its revenue.

One layer up, you have institutional investors, such as hedge funds, which “shorted” GameStop, or bet that the value of the stock would decline. Depending on how you look at it, short sellers are heroes of capitalism identifying rotten companies and industries on the verge of collapse, or they’re corrupt worrywarts picking on lovable, vulnerable firms.

Either way, GameStop was one of the more popular targets of these hero-villains. By one metric, the company was the second-most-shorted firm out of more than 6,000 companies listed in the New York Stock Exchange and Nasdaq. If GameStop’s stock continued to fall, as it had consistently since 2013, hedge funds that had bet against the company would have gotten even richer than they already are.

But they didn’t. That’s because, as short sellers were targeting GameStop, online investors were cooking up ways to target the short sellers. A band of Reddit users, led by a trader who goes by the YouTube name “Roaring Kitty,” had for months been eyeing GameStop as a tasty investment. Over the course of several months, they spelled out a detailed plan to buy up GameStop’s stock and push up the price, punishing the hedge funds and forcing them to cover their position by rushing to buy back shares, which would push up the stock’s value even more.

This is called a “short squeeze,” and it seems to have served at least two purposes for the Reddit investors: sticking it to hedge funds and getting a little rich. Both happened. One hedge fund, Melvin Capital Management, has lost at least $2 billion, while Roaring Kitty is now estimated to have made more than $13 million on his GameStop investment.

Encasing all of this is the investor craze of the past few days, as Reddit’s GameStop scheme went viral. Ordinary investors with FOMO have piled into the stock. On most days this week, GameStop was the most exchanged equity in the world, with $20 billion of trading volume daily.

This perfect storm was created by the collision of a tantalizing morality play (Reddit Degenerates versus Wall Street Suits) and an age of commission-free trades on popular platforms such as Robinhood, which have converted the raw material of pandemic boredom into a juggernaut of speculation.

Given the monstrous amounts of money at play, several large institutional investors—rival hedge funds, private-equity firms, billionaire tourist dollars—seem to have jumped in as well, scrambling the most simplistic David-versus-Goliath narratives.

And America’s investor underdogs might already have lost the war as the stock price ticks down. This populist revolt could reveal itself to be a disastrous bubble that offers and then quickly extinguishes the idyllic dream of democratized finance.

Breaking down the GameStop saga into these four components—the company, the short, the Reddit army, and the ensuing FOMO mania—is useful because this helps us disentangle the parts of the story that are surprisingly traditional from the parts that are actually surprising.

“The longer you’ve been around, the more you realize that something like this is less a massive break in the functioning of markets and more a reflection of risks that were always there,” says Michael Cembalest, the chairman of market and investment strategy at JP Morgan Asset Management.

Manias have been parts of markets for centuries. So have short squeezes. And in this case, the hedge funds betting against GameStop might have received just deserts for a really dumb bet.

As a matter of practice, the best strategy for short sellers is typically to identify ostensibly good companies with an Achilles’ heel. You take a position when the firm’s stock is high. Eventually the market finds the weakness you’d identified, and then the stock falls, at which point you make a bunch of money.

But GameStop for the past year has been the opposite of all that. It was a bad company, whose stock had already fallen from $56 a share in 2013 to about $5 in 2019. GameStop’s short sellers were essentially betting that a company publicly valued as “horrendous” should really be valued at a level commensurate with the notion of “truly horrendous.” They risked billions of dollars on the financial equivalent of a qualifying adverb.

It’s really risky to aggressively short a company whose stock, having fallen 95 percent, is floating around $5; there just aren’t a lot of numbers under five. Plus, companies in GameStop’s situation can always try to restructure their operations, or appeal to a white knight, or exit the business and sell off their commercial real estate, or do something else when the cost of capital is basically zilch.

What’s new here is the presence of Reddit and Robinhood. The GameStop trade briefly conquered the world by taking advantage of two things the internet does very effectively. First, the internet is really good at manufacturing upstart sects, for good and for evil. You can despise the Capitol siege of January 6 (I do) and adore the GameStop surge of January 26 (I’m undecided), but still see something in common: two anti-institutional plots conceived in online message boards, amplified on broader platforms such as YouTube, and actualized, chaotically, in the real world. Tens of millions of people in this country who are soaked in the attention economy are, apparently, eager to throw their weight behind some 15-minute-famous cause, and it’s not always straightforward from the onset which ones are safe and virtuous and which ones are not.

Second, the internet democratizes access to information and communication—again, for good and for evil. “Retail investors with the help of technology acting as a union in attacking is a new phenomenon,” Jim Paulsen, an investment strategist, told CNBC. “You combine the power of technology, which allows you through Reddit postings to magnify your individual impact, with some use of leverage and very targeted bets, [and] they can have a significant influence.” That’s right, but the democratization of finance is, like the democratization of everything, a rose with thorns. GameStop’s stock has soared, not in response to its economic fundamentals, but in proportion to the number of people paying attention to it.

Maybe the only long-term outcome of the GameStop fiasco is that hedge funds will be more cautious about establishing enormous short positions in cheap brand-name companies, and investors will learn that stock manias, like memes, disappear as quickly as they go viral. Perhaps all we’ll remember from the past week is that a few hedge funds’ greedy doltishness accidentally helped mint some Robinhood millionaires, while a bunch of latecomers set their money on fire for lolz.

But something tells me that we’re at the dawn of something stranger. For a week, takes have flown wildly around the internet that tried to capture this saga in a tweet. The investor and former Trump White House communications director Anthony Scaramucci compared what we’re seeing now to the “French Revolution of finance,” with an army of scrappy traders engaged in a moral uprising.

Others worried that the GameStop bubble was turning into a collectivized Ponzi scheme, in which innocents were being lured into a ruse that would take all their money after the market corrected. Given that online trading has been restricted and the company’s stock is now in a free fall, both the Mooch and the Debbie Downers might be right. When the French Revolution ended, some of its most eager proponents lost more than an arm and a leg.

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