Redditors pounced on flaws, like others before them
To think it all started with a Reddit thread.
As members of the Reddit group r/ WallStreetBets have argued, institutional investors of privileged Wall Street have long exploited Main Street’s ordinary investors, so now was their chance to turn the tables on Wall Street to get their share from a gamed, corrupt system.
So, the Redditors, as they’re called, decided to short-squeeze hedge funds which bet against GameStop, trapping them by driving up the share price.
Like other hedge funds caught in the wave, Melvin Capital needed a bailout — $2.75 billion (U.S.) to cover its losses from betting on GameStop’s stock price going down, due to its weak fundamentals in the dying industry of physical video game retail.
The Redditors had done what hedge funds wouldn’t have hesitated to do themselves if they were in the same position: take profit at another’s expense. What differentiates the investing speculation by the masses from that of these privileged members of Wall Street and Bay Street?
Hedge funds profit on the basis of a business failing. They take short positions with no other purpose than making money from such failures, without providing to society any social good in exchange.
Also, traditional brokerages give their brokers directions and lucrative financial incentives to promote selected stocks, and offer exclusive securities and IPOs to their preferred clients to the disadvantage of the general investing public.
Opportunities aren’t given out equally, and sometimes neither are punishments. Consider the subprime mortgage crisis in the U.S.: many pensioners and homeowners were left reeling at the time as banks found they had overextended themselves in risky lending derivative products. Yet while many homeowners with subprime mortgages lost their homes, most banks walked away unscathed, thanks to government handouts.
These aren’t just American regulatory and market failures. One need only remember the once prominent names of Nortel, Livent, Bre-X, Hollinger and other extinct Canadian companies with dubious financials that left investors and pensioners reeling and holding the bag of losses — despite having regulators in place to protect investors and a flawed belief that markets are honest, efficient and not subject to manipulation.
Robinhood, the aptly named trading app, prided itself as being on the side of the little investor, and let any investors trade without trading commissions, a democratizing effect allowing anyone to “get in the game.” Then, RobinHood had to hit the brakes, restricting trading in GameStop and other Reddit targets, to ensure its capital reserves and margin still met regulatory requirements for brokerages.
The damage has already been done, exposing financial markets as subject to manipulation, whether by Redditors or sophisticated investors.
None of the stocks embraced by the Redditors for price support amid short selling— others included Canada’s BlackBerry, movie-theatre chain AMC, American Airlines and Trivago — justified their inflated prices. Jordan Belfort, once the ignominious “Wolf of Wall Street,” called the Redditor-led investor revolution no more than “a pump and dump” stock scheme.
However, unlike traditional pump-and-dumps, it is hard to identify the coordination that securities regulators would normally key in on, especially among anonymous Redditors with usernames like “Coldcutcombo69.”
Identifying companies, applying some plausible logic to investing in them, and letting the masses do their work through collective euphoria to grow the stocks’ prices and therefore profit is not in itself any different from how the market historically and currently already works.
Without underlying income and earnings to buffet the stock price, these buffeted stocks are bound to fall due to poor fundamentals and deteriorating macroeconomic conditions with a resurgent COVID-19. When that happens, many investors will cry foul and ask for stronger regulation and capital and margin requirements on the trading brokerages. Eventually, regulators may restrict trading sites and treat investing discussion threads as a mechanism for stock manipulation for additional regulation.
Until then, it is important to recognize that this frenzy of social media inspired trading merely reflects the flawed system and inefficient markets already in place.