Untimely meditations on a mania

Gamestop’s market capitalization (share price multiplied by number of shares, a measure of valuation for the company) exceeded $22 billion by the end of this week, up from the quarter of a billion it was valued at the same time last year. This $22 billion valuation is greater than the market capitalization of Kellogg’s, the cereal company with over twice as much in annual revenue, and just short of Best Buy, a larger retailer that actually has profits and operates in comparable sectors. The causes are various, but the catalyst appears to have been a reddit group (subreddit) called wallstreetbets. People have struggled to make sense of these events because they don’t make sense. This has not prevented people from trying to explain what is going on, often without addressing the most important questions and relying too heavily on the accounts from parties who benefit most from spreading a particular narrative. I will consider the parts that have gotten missed.

0. The mechanics of what is going on

One frustrating rhetorical device that runs through the coverage of this event is that articles will accurately describe the unfamiliar mechanics behind the mania, and then proceed to uncritically report the analysis from wallstreetbets as the account of what is going on. Explaining unfamiliar financial concepts is useful, but placing the opinions of active participants beside this explanation gives these views an unwarranted appearance of authority. This is also repeated to a lesser extent in the general discourse around the mania with participants essentially quoting the subreddit verbatim as if it were their own ideas. With this concern in mind, I am relegating the technical aspects of what happened to this section and it may be safely skipped if one is familiar with the underlying financial concepts.

A share represents partial ownership in a company, issued by a company in order to raise funds. This ownership stake implies a claim on future earnings, assets, and the ability to vote (though there are different classes of shares and so shareholders). For most companies these ownership shares have financial value and so can be traded in a secondary market, either privately or, more commonly, on a stock exchange. The share price is the last price at which a trade occurred. As with most markets, prices increase when the demand for a share exceeds the number available as buyers outbid each other, and prices fall when there is an excess of sellers who need to entice prospective buyers with more favourable terms.

While some analogies to more familiar markets can be helpful, markets for financial assets are quite complex. For instance, the market for clothing does not lend itself to an analogy for short selling. Buyers for financial assets do so with the expectation of some kind of return, either through periodic payments (dividends), or an increase in the value of the asset by the time they sell. It is, however, possible to profit from the decline in a share price. Such a position is known as being short (the same kind of short referred to in the title of the book and later film The Big Short). Short positions can be achieved in a number of ways, but the one most relevant to the present discussion involves borrowing the asset. In essence, the investor borrows a share from another investor, with the understanding that they will buy a replacement share when they close their position. If the expected decline in share price occurs, investor buys back the share at a lower price and pockets the difference (less any fees, interest, or dividends over the intervening period).

Short positions are more complicated when the price does not fall as expected. The investor has made a commitment to buy the share when they close their position, but the fact the share must be bought for more than the investor received for selling the borrowed stock invites a question about the investor’s ability to pay. The losses from a long position (such as ownership) are limited to 100% (the share price goes to $0), but there is no practical limit to the losses from a short position since there is no practical limit to the price a share might reach. It is common in these cases for the investor to be made to post collateral, and if the position turns against the investor too severely they may be made to post more collateral or have their holdings liquidated to bring the account in line (an event known as a margin call, also the name of a much better movie about financial markets than The Big Short).

We now have everything we need to understand the behaviour of the price of shares for GameStop this week. GameStop has struggled to adapt to changes in the marketplace (specifically a decline in the sale of physical media) and, like many retailers, has been affected by the measures intended to slow the spread of COVID-19. Investors are pessimistic about GameStop’s ability to turn the company around, evidenced by its high short ratio (the ratio of shares sold short to the average daily volume traded. GameStop’s short ratio is about 15, in contrast to 3 for Best Buy and 0.5 for Apple). Around August 2020 the share price started to recover from its lows. After January 12 of this year the share price reached a level not seen since 2016 (then attributed to new members appointed to the board with their e-commerce experience with Chewy Inc.), and the share price broke through its historical maximum on the 22nd.

While at least part of the increase might be attributed to a more optimistic feeling towards GameStop’s prospects relative to the market’s assessment, the most substantial activity appears to have been driven by wallstreetbets’ heavy push to buy and hold GameStop shares, reasoning the pressure that the resulting price increase would put on investors who were short would force them to close their position, buying at the inflated price, an event known as a short squeeze. This is what happened to Melvin Captial, a hedge fund, and potentially Citron Research (which has been reported as a hedge fund, but I have only seen listed as a newsletter). This brings us to the end of the week with the share price at $325 (slightly off from its peak of $347.51).

The fallout from these events will be the subject of the rest of the article, but my hope is to delineate between normative claims and the events that have given rise to those claims. Put succinctly, GameStop’s share price has experienced a sharp price increase in response to a concentrated effort to raise it, at least one hedge fund being forced to contribute to the upward pressure through covering its short position, and a wave of new buyers entering in response to the extra attention brought on by the large increase.

1. What good is short selling (or financial markets in general)?

The financial sector is not a beloved segment of the economy. The anger is deeper than what one normally might expect from borrowers outnumbering lenders, and for some likely predates the global financial crisis of 2007-2008, though this is certainly as convenient a marker as any for popular mistrust and anger at the sector.

There are plenty of people who simply do not know (or at least did not know) that it was possible to profit from the decline in an asset price. When some people learn of this, they find the idea incomprehensible. Not everyone who dislikes something will take the time to study it, and it is fair to say that least some of this failure to understand is a willful ignorance, comparing finance to religion (a matter of belief). The comparison to religion isn’t entirely misplaced, since the prices from financial assets from dollars to options ultimately reflect a belief in the asset’s ability to be converted into the “necessities and conveniences of life.” Likewise, the kind of person with a propensity to engage someone questioning the utility of financial markets is also likely leaven the exposition with some dogmatic beliefs about those markets.

Assuming one will at least allow for the utility of financial markets and some logical consistency of the system (even if only malevolent), short selling is still a controversial practice. The initial public offering (IPO) of shares is a way of financing a business, and the secondary market allows people to turn those shares back into money. The ability to borrow and sell a share does not appear to have any intuitive value. Short selling is already regulated and was temporarily banned for financial shares in 2008 in response to the financial crisis.

One objection stems from the idea of borrowing someone else’s share. It is true that some brokers permit shares to be borrowed without the owner’s knowledge (the consent being obtained upon opening the account). Borrowing someone’s jacket, selling it, and then buying a replacement when it goes on sale sounds like the sort of thing that might show up in a police report. As it happens, borrowing shares are not the only way to obtain a short position. Even in the borrowing case, the practice is not as counterintuitive as it seems. In some cases there are fees or interest paid as with any other kind of borrowing. In fact, it’s quite similar to what happens to our paycheques when they are deposited in our bank accounts. We do not get to sign off on the bank making the loan to our neighbour with the money we have deposited; we only carry the expectation that we be able to withdraw what we have deposted from the bank when we need it.

The substance of the objection is not simply a matter of a misunderstanding or disagreement over the technical details. Companies certainly do not like the idea of short sellers profiting from a falling share price, since it is in their interests to see it increase. Given that the value to society seems to stem from being able to undertake projects with larger financial commitments than could be obtained through a single lender (not to mention the benefit of spreading the risk through fractional ownership instead of each undertaking being a make or break proposition for the investor), there is a question as to why we should want to create a situation in which there is profit in seeing the value of a company fall.

Proponents of short selling argue that the benefit to short selling is price discovery. I think this is a reasonable argument in favour of the practice. Theranos operated in an environment where the only option was to buy or decline. The company raised $700 million without producing the product it claimed to make until finally being exposed by internal whistleblowers and an investigative journalist for the Wall Street Journal. In contrast, the problems at Enron, a major scandal from the dot com era, had been correctly identified by short sellers, and the shorts surrounding the financial crisis brought on by a speculative bubble in the US housing market are the subject of a popular film. It is fair to say that the identification of problems by short sellers did not ultimately prevent the catastrophes, but it does at least provide some evidence that the financial incentive did create scrutiny towards assets that merited such attention. If we are going to judge the practice on its efficacy, it is also worth noting that the ban on short selling did not seem to have any effect during the financial crisis and certainly didn’t prevent the crisis from getting worse. Ultimately a market is going to involve buyers and sellers, and we should do a better job identifying the harm brought on by short selling before seeking to ban it.

2. Is wallstreetbets the little guy?

My greatest frustration with the reporting on this issue is the willingness of reporters to effectively be stenographers for the wallstreetbets narrative that this is a David and Goliath story. In broad strokes this story is that wallstreetbets is just a collection of retail investors finally sticking it to hedge funds (a villain straight out of central casting) and exposing the corruption within financial markets.

If you look at the wallstreetbets posts beyond simply picking up bullish GME (the GameStop stock ticker) takes and pro wallstreetbets talking points, you are going to see some very unusual behaviour for simple Joes and Janes trying to exercise their god given right to participate in financial markets. These average every day retail investors have tens of thousands of dollars to speculate on a strategy that depends on an understanding of short selling (an activity that at least brokers in Canada require an additional set of forms that include the “I know what I’m doing with this elephant gun and it’s my own fault if I blow my leg off” disclaimer). These hardworking ordinary folk also talk about gamma squeezes.

What’s a gamma squeeze? It’s quite simple. You already know about the short squeeze. The gamma refers to one of “the greeks” of the Black-Scholes model. The gamma is the second derivative of value with respect to the spot price. To calculate it you can take the squared volatility of the asset and divide it by two, then add the risk free rate, and then multiply it by the time to maturity. Add the natural logarithm of the spot price divided by the strike price to the resulting number. Then divide all that by the square root of the time to maturity times the volatility of the asset (or multiply it by the reciprocal of the square root of the time to maturity times the volatility of the asset. It’s the same thing). Oh and the time should be in years, but you probably already knew that. Now, take that number, and put that into the probability density function (pdf) of the standard normal distribution. That gives you the numerator. Divide that by the spot price times the volatility times the square root of the time to maturity and you’ve successfully calculated the gamma. Frankly, I’m a bit embarrassed to elaborate on such a basic concept, but I’ve wanted to make this article accessible to a level even below a retail investor.

Now, the fact of the matter is, even the wallstretbets posters probably don’t actually solve the partial differential equation behind the Black-Scholes formula or even know it that well. Any profession is going to have its specialized terminology, and you don’t need to understand the underlying mathematics to be able to apply the insights of research (although I would argue that you really should if you want to avoid saying something foolish, and this goes doubly for financial applications. I don’t ‘get’ the Black-Scholes model beyond the Wikipedia article, but I also don’t trade individual stocks). What this serves to illustrate is that you don’t need to look too hard to see that these are not average retail investors.

Remember the ‘Pharma Bro’ Martin Shkreli? Former member of wallstreetbets. Former moderator in fact. This isn’t an attempt at guilt by association, but it does help explain why so many of these supposedly little guys have access to Bloomberg terminals. It’s fair to say that Shkreli and plenty of the people behind wallstreetbets are smart. There’s a whole group of people who look up to him. It is also very fair to say that smart does not mean ethical or at all aligned with your best interests. I just don’t see why there’s any reason to paint this as some kind of grassroots uprising, and it’s irresponsible for people covering this story not to point out the difference in sophistication between the leaders and the people piling on in response to the wild price movement. This redditor put it best:

“WSB’s power users are younger finance bros. It’s 30s investment bankers and portfolio managers memeing with each other and cosplaying as ‘autists.’ If you didn’t know what a gamma squeeze was 48 hours ago, you are their exit strategy and the down payment on their next Porsche.”

u/The_Law_of_Pizza

3. Isn’t it only the hedge funds that get hurt?

wallstreetbets has done a good job in building a narrative. The justification for the trade goes something like this. The movement is about buying and holding GameStop (here you can do a nice bit of improvisation about GameStop being a beloved retailer that raised that community and really let the muse move you) and only selling when the hedge funds are closing their short positions, redistributing the wealth better than any government program (namely, into the pockets of anyone who comes along on this scheme). As the quote in the previous section suggests, this isn’t really what’s happening.

There’s a market manipulation strategy known as pump and dump. If you watched The Wolf of Wall Street (don’t bother if you haven’t. The pen sale is the one good bit and lasts less than 30 seconds) you’ve seen this in action. It involves promoting misleading positive claims about the shares (the pump), making the share price overvalued at which point people in on the scheme sell (dump) their shares, effectively transferring the wealth from those taken in at the pump phase into their pockets. This activity is illegal, and there are some important factors that could make what’s happening with GameStop different from this old scam.

Certainly if this is a pump and dump scam, it’s a modified version of it. There isn’t a clearly false claim such as insiders revealing that GameStop is about to announce an exclusive partnership with Sony, Microsoft, and Nintendo to be the only source for console hardware for the next 7 years. There certainly is some speculation as to the future actions of short sellers (which has at least borne out in the case of Melvin Capital), but there at least seems to be some kind of investment thesis behind the advocacy and the fact that GameStop is traded on an exchange means a lot of the regulations designed to prevent the scam not applicable. The fact that wallstreetbets has managed to succeed in creating a mania large enough to affect a stock on an exchange isn’t quite enough to completely dismiss the parallels.

The fact of the matter is that there are already people who have bought in on this scheme and have lost. This was bound to happen. It’s also important to note that the short sellers are not obligated to follow wallstreetbets’ playbook. There is reason to believe that declines in stock market indices are the result of funds selling long positions, producing a loss for, well, basically retail investors who aren’t in on this GameStop idiocy (note, this is a paper loss so long as these investors don’t sell. I have more faith in the affected assets to return to previous levels than I do in the viability of making money on GME at $325 a share). If you’re short and believe in the soundness of of your GameStop strategy, or at least believe you can cut your losses at less than the current $325 price, then it makes sense to adjust your holdings to be able to weather the current situation than to take a substantial loss.

Hedge funds are not a monolith. The fact that Melvin Capital was poorly positioned for their short does not mean everyone else is. There are large wall street firms like BlackRock and Fidelity that are among the top holders of shares in the company. Almost 75% of the outstanding shares are owned by 10 entities. Silver Lake Partners, a private-equity firm that invested in AMC (another company affected by the mania to a lesser extent) without relying on the expectation of a mania, cashed out its investment for a $113 million profit in response to this week’s activity. When all is said and done, the people who will have made the most from this will be the sophisticated players: wallstretbets pushers and funds nimble enough to capitalize on the mania.

4. This is not a movement

More accurately, this is not the kind of movement people are saying it is. Coverage of the wallstreetbets mania is making it sound like a retail investor driven occupy wall street. There’s certainly no shortage of takes that this is a better form of occupy wall street that uses the market’s tricks against them. This view is inconsistent with the actual behaviour of the participants.

The main difficulty in comparisons to occupy wall street is that most of these takes can’t pick a lane. Either the behaviours exhibited in financial markets are not to the common good and should be reigned in, or wall street’s behaviour has been fine all along, and retail investors are finally catching up. Your politics may lead you one way or the other, but accepting the first removes the method through which wall street gets its comeuppance, while accepting the second provides no more motivation to target hedge funds than any other investor a particular strategy will work on. More people invested in discussion around the wallstreetbets mania seem to adopt the second view while failing to realize the implications it has for the relationship between the subreddit’s ringleaders and the group who is being encouraged to buy and hold.

If we’re honest with ourselves we know the true beliefs behind this group. The participants in this mania (and a significant contingent of the ‘mad at wall street’ crowd) are perfectly comfortable with unfairness in financial markets, so long as the odds are tilted in their favour. Very few of us are equipped to confront these kinds of truths about ourselves, although some people really do have principled and reflective commitments to fair markets or their abolition. The majority have not thought very deeply about these issues and will evaluate things along the axis of their private benefit. With so many stories of how people “changed with money” maybe we should be asking what was there all along.

Manias have been with us since tulip bulbs sold for 10 times the annual income for skilled labour in Holland in 1637. Individual details may vary, but the core story stays the same. There are some surprises in the current mania, but on reflection the most surprising one to me is why something like this didn’t happen sooner. Influencers are a known commodity, and are found everywhere from education to cosmetics. It was only a matter of time before someone would leverage the kind of attention these kinds of outreach generate towards financial markets. A YouTuber who is a significant force behind the mania is a Chartered Financial Analyst (CFA, a postgraduate qualification for financial professionals) who worked if not works in the financial sector.

The subreddit has done a magnificent job of creating a feedback loop. GameStop is a recognizable name, and gamers do have a tendency to form mobs and get excited when they show up in the news. Stories about people being able to afford medical care are upvoted. Memes about children raised on GameStop growing up coming to save the retailer in its dotage are shared (never mind that absolutely none of this will help GameStop or its employees except perhaps have more people listen to the next earnings call). People rail against the unfairness of hedge funds’ access to special markets or share theories as to how Citadel (or even Ken Griffin personally) has conspired to stop the squeeze at all costs. This is why I didn’t want to dismiss the religious analogy earlier. These are articles of faith. Those holding are the elect, and paradise awaits those who endure the present tribulations. We already know the losses will be blamed on market manipulation on the part of hedge funds.

Few of us really want to admit when our motivations are “as long as I get mine.” wallstreetbets will tranquilize those concerns by letting you be part of a movement. The media’s willingness to be stenographers for this narrative is at least partly responsible for a fresh batch of rubes to drive the price up, turning up the FOMO (Fear of Missing Out), bringing in new converts, and fattening the payday for the investors who know what they are doing. It is not a coincidence that there have been multiple days of posts explaining it’s “the last chance to get in on the squeeze.”

I wonder how many of the people buying GameStop shares watched the storming of the Capitol and wondered how people could be so captured by a lie. We really do like to think we’re a lot smarter than we are, but there’s a reason science majors can still fall into conspiracy theory, geniuses get taken by frauds, and seemingly level headed people join cults. If anything the wallstreetbets mania is easier to fall into than the cases we know have successfully taken people in. If we’re willing to lie to ourselves about our motivations for doing something (who really wants to admit they’re buying GameStop shares because they hope they can make money with very little effort and leave someone else holding the bag?), then why not latch on to the narrative that this is part of some larger arc of history finally bending back towards the little guy and away from the plutocrats who are the real reason we couldn’t get ahead?

5. This probably won’t matter in the long run

In the long run, this mania is going to be kind of like saying “all your base are belong to us” or referring to the unexplained video of three identical Barack Obamas showing up at the White House press correspondents dinner (both memes coinciding with the bursting of a speculative bubble). It will immediately date you, earn a knowing smile from a certain group that’s in the know, and you will become extremely annoying if you let it linger any more than a passing reference.

We’ve had manias before. This isn’t even a particularly interesting one on that front. The fact that a hedge fund was too aggressive in its position against GameStop and had to close it when things turned against it does not mean that there was some systemic flaw uncovered by retail traders. It’s maybe a little weird that the participants willingly acknowledge that the assets they are holding are not actually worth the price they are trading (and potentially that they bought) at, and that the mania itself is very obviously manufactured, but otherwise, we’ve seen this story before.

The YouTuber’s comment section has people mentioning “Just commenting so I can be part of history.” This event is historical in the sense that it was mentioned in papers of record and will make an interesting footnote in some crowd psychology papers and maybe a fun Jeopardy question. The circumstances under which this kind of trade works are very narrow. For context, how much do you think about the Bitcoin “HODL” case (this meme, of course, returning for the GameStop mania)? This was in reference to a price spike and crash in late 2017 (the wiki identifes the term as originating in 2013, but widespread usage clearly correlates with with the later event). What did we learn? Very little apparently. Bitcoin buyers certainly claim to be ideologically motivated, much like the GameStop crowd. The reality of the market caught up with them and was indifferent to their claims of ideological purity.

Melvin Capital is not Long Term Capital Management and while it seems like this mania will affect the broader market in some ways (this is addressed in 3 above), they are not likely to be long lasting or severe. There will be no bailouts and the only people who will think about it for an extended period of time are the people who make or lose a lot on this speculation. This does not mean that there will be a lot of political hay to be made out of this incident. In fact, the most likely outcome will likely be restrictions on retail trading.

6. Should retail investors be able to make dumb choices?

Up to now I have not addressed a fairly major event that incensed the wallstreetbets crowd and has prompted the comment from lawmakers: the decision by Robinhood and several other brokers to restrict trading of GameStop shares. Even if you didn’t have access to financial information, you could see the GameStop mania by looking at Robinhood’s jump up the charts in the App Store. Robinhood is a commission-free broker that has been popular for the purposes of buying GameStop stock. Indeed, the introduction of an app like this might explain why this specific kind of mania hasn’t happened before, as it significantly lowers the barriers to trading individual shares. It is also telling that the sophisticated players in the wallstreetbets subreddit do not appear to be using the app.

On January 28, Robinhood and a few other brokers restricted trading for GameStop and other affected shares to sell only. wallstreetbets developed its theory as to how the hedge funds were behind it. Citadel Securities processes about one third of individual trades and about half of Robinhood’s. Citadel Securities’ parent company, Citadel LLC, also helped bail out Melvin Capital after they were hit by the short squeeze. Depending on who you read, either Citadel either threatened to cut Robinhood off from trading if it did not restrict trading of the stocks that were part of the short squeeze, or that Ken Griffin (founder and CEO of Citadel) otherwise conspired with Robinhood to keep retail investors down.

As with other aspects of this story, this account was uncritically repeated, and drew the attention of lawmakers, including Ted Cruz and Alexandria Ocasio-Cortez. Maxine Waters announced that the House Financial Services Committee would hold a hearing. Hearings and inquiries can, of course, mean anything. As it happens, I don’t think a hearing about the relationship between Robinhood and Citadel would be a bad thing since Robinhood makes significant money selling orders to firms like Citadel and this practice concerns both regulators and consumer advocacy groups. Hearings on GameStop are less likely to produce something useful.

Robinhood’s own account of the restriction explains their actions in terms of regulatory requirements. Their claim is that the volatility brought on by shares like GameStop increased their deposit requirements for a clearinghouse (an essential component to the broker) ten-fold, and so trading in the shares that brought about that volatility was halted in order to bring the company back into compliance. In the broadest possible terms, volatility is associated with risk, and higher risks require larger deposits to protect the clearinghouse.

Robinhood isn’t likely to just come out and say “we know where our money comes from and that’s why we restricted trading” any more than wallstreetbets is going to say “I can’t believe you idiots are giving me a down payment for another house!” The possibility of some secret arrangement between Robinhood and hedge funds isn’t the kind of theory we can test right now, but we can at least examine possible explanations for the kinds of behaviour we have observed and see which stories make sense.

I am clearly unsympathetic to a lot of the subreddit’s claims and so I am not likely to do the secret deal account any justice, but I also think this is because the story doesn’t make a lot of sense. Melvin Capital has said they have closed their position, and Citadel’s investment came as a result of the short squeeze. This is to say that any losses Citadel would experience could be accounted for when planning the deal. There doesn’t seem to be a lot of discussion about Citadel’s own exposure to the short squeeze, but presumably a firm that is fearful enough to engage in highly unethical, if not outright illegal (by wallstreetbets account. I am far less certain of the legal claims they discuss), activity to prevent the worst of its losses does not sink $2 billion in to a firm just burned by the very same event (remember, the margin call, discussed in section 0, happens when an investor does not have sufficient collateral and so investment in Melvin would put Citadel at greater risk if it had exposure to the squeeze. For context, $2 billion would be enough room for a short position the size of the largest ownership stake to withstand a 64% increase from the current price of $325).

I suppose one could argue this confidence comes from its knowledge it can manipulate the situation to its favour, but Citadel is not omnipotent, and that is one contortion too many for me. I’m not sure the story of some kind of collusion between Citadel and Robinhood is designed to convince an outsider so much as it is one for people who have already adopted the subreddit’s narrative. Whether or not the short squeeze will work is an open question. We know at least one hedge fund closed its position at a loss, but so far that has been the limit of the strategy with regards to hedge funds (the claimed target). This narrative relies quite heavily on the squeeze working extremely well in addition to Citadel’s exposure to it.

We have already covered Robinhood’s own account of their actions, but I would like to consider some other factors. First, to my best understanding, there is no requirement for a broker to allow trading for every asset. Stock Exchanges also introduce halts in trading usually in response to extreme price movements or the release of financial information. Limits to the ability to trade certain assets are already a given.

Here is a thought experiment. Suppose you are responsible for running a broker and you see that one of the assets you trade seems to be in a speculative bubble or is otherwise experiencing some kind of manipulation. Ignoring the deposit requirements brought on by volatility (Robinhood’s actual explanation) let us say you do not wish for traders to participate in this asset for some reason. The motivation can really be anything you’d like, from a benevolent concern that retail investors will be negatively affected by the speculative bubble, to self-interest in the form of avoiding congressional hearings for failing to protect retail investors, we’re only taking it as a given that the broker wants to stop trading in the affected assets. How would you implement the halt? Do take a minute to think this through as it will be helpful to see how thorny it gets.

There’s a good chance you settled on the view that the subreddit has (even if you haven’t read it) which is that either buying and selling should be permitted for the asset or all trading for it should be halted completely. My first reaction was that the lopsidedness of the choice was strange and my mind immediately went towards the narrative that wallstreetbets had prepared for me, that it was specifically designed to blunt the short squeeze to the benefit of hedge funds. This reflected careless thinking on my part. Consider if you were someone who got swept up in the mania and decided for whatever reason you wanted to exit. If selling is restricted, the broker is effectively forcing you to watch the drama play out and probably watch the value of the share fall, despite your full intention and desire to liquidate it. It may be possible to transfer the shares to another broker, but your original broker has still potentially exposed you to a loss you didn’t intend since such a transfer is not likely to be instantaneous (amusingly, one solution here might be to short the company you intended to sell with another broker to cancel out any losses you might experience during the transfer). In this light, the decision to permit selling seems very much in line with the interests of retail investors, allowing them exit the position if they wish, but not to add to it (whatever the motives may be).

While the decision to restrict trades for the affected companies to sales only may be to the retail investor’s benefit, it does not address the more fundamental objection raised by wallstreetbets, that hedge funds are able to trade freely while retail investors are restricted. This was the sentiment echoed by Alexandria Ocasio-Cortez and Ted Cruz. Despite the support from legislators, this view is unconvincing when considering the broader picture. It is worth considering why hedge funds exist in the first place. Hedge funds are the result of a recognition that there are complex financial strategies that may be beneficial to permit, but should not be accessible to everyone. Hedge funds are restricted to institutions, high net worth individuals, or individuals deemed sufficiently sophisticated within the regulatory framework (for instance, if you are employed by the hedge fund and do not otherwise qualify this exception should avoid the absurd outcome where you are sophisticated enough to trade for it but not invest in it yourself). The very existence of hedge funds comes from regulators recognizing that there are differing levels of sophistication among investors and are designed to protect retail investors from the riskiest strategies. The current regulatory framework is what prevents your financial advisor from recommending a fund that uses a dizzying array of options while leveraged to the hilt with absolutely no margin of error. Hedge funds are restricted to institutional investors and high net worth individuals because these are the people who can afford to take a bath if the manager does something stupid and makes the investment go to 0.

Likewise, not all trading happens on stock exchanges. Even without hedge fund restrictions, it will always be true that some markets are available to some people and not others. Want to trade on the ICX alternative trading system? Better have your membership in the Investment Industry Regulatory Organization of Canada. Want to discuss the creation of a specific financial instrument based on an elaborate smart contract with millions of conditionals based on specific indicators? You can if you can get in the door to a financial institution that will sell it to you and that meeting will be significantly easier to get if you are a member of the Walton family.

Yes, it is true that hedge funds have access to markets that retail investors don’t. This is largely a reflection of the fact that we place more restrictions on retail investing to prevent the retail investors from being taken advantage of, not to give an advantage to hedge funds. The restriction at the heart of this objection wasn’t even particularly inconvenient for retail investors. Fidelity, Schwab, Vanguard, and E*Trade (and likely others) did not seem to have any interruption in GameStop trading. The group most likely to be affected by a restriction on buying GameStop was the group least likely to know what they were doing. The question seems to be how much we should be enabling retail investors to make dumb and risky trades.

The fact that the narrative of “wall street is trying to stop you from making risky bets because you might get rich” has bipartisan support does not make it any less stupid. As a whole I do not think members of congress or elected MPs should be pushing the idea that speculative bubbles are somehow a win for the little guy or that this unhinged valuation is the responsibility of hedge funds. One lawmaker who has been a welcome exception has been Elizabeth Warren, who asks remarkably sensible questions in her letter to the acting chair of the U.S. Securities and Exchange Commission (SEC). Her questions are focused on the proper functioning of financial markets. After reading the tweets from people like the two Teds (Cruz and Lieu) and Alexandria Ocasio-Cortez, Warren is the only one who comes off as serious, informed about the role of financial markets, and committed to ensuring that they continue to be a benefit to society. The others seem to accept the premise that stock market speculation is a really good way to get rich quickly and that the real problem is wall street is getting in the way of your millions.

Stock markets have enabled societies to undertake big projects since at least the 17th century and to reap the benefits of this economic activity. They are a powerful tool that can carry great dangers and so they are regulated to ensure the balance is in favour of the common good. Similar markets (bond markets) are how governments finance their own large undertakings. The wealth an individual can generate from speculating in such markets is not the focus, but rather a mechanism through which those markets can operate efficiently and so provide the most benefit to society. If the contest is between the “fair, orderly, and efficient” functioning of financial markets and individual gain, the priority should always be given to the former. The fact that the broader population are under the misconception that financial markets are a casino with favourable odds to the wealthy does not mean that lawmakers need to work towards making this reality.

7. What should we take away from all of this?

The lesson should be simple: it is undesirable and infeasible to make a lot of money quickly and without effort. We collectively would be a lot better off if we stopped thinking that making money without earning it is somehow a good thing. Is it really that repellent to put in some effort to earn money? Clearly there are people who put in tremendous effort and earn very little. This article is silent on them. My question is what is so great about gaining wealth at the expense of another or through a few lucky strokes on the keyboard.

There will be people who do make a lot of money off of this mania. The wallstreetbets leaders have certainly put a lot of effort into pumping up the crowd and executing the strategy, though I hardly think this is something to be proud of (however clever it is). There will be some people who didn’t know any better, managed to get in early, and walk away with a healthy payday even if the underlying decision was reckless. You think financial markets are unfair? Wait until you hear about this life thing.

Much like the crowd who made significant money off of cryptocurrencies, these people will be awful and it will be infuriating to listen to them on interview programs. All I can return to is the question: “What did they do to earn this?”

Our work is a contribution to society. We may not be appropriately compensated for it, but there are worse things we can do than earn a living. This should apply no matter what one’s political beliefs are. Wishing for a world in which wealth appears without effort is either wishing for a world that doesn’t exist, or wishing for one in which we claim the effort of others without contributing anything ourselves.

There is another story we can take out of the GameStop short squeeze and it takes the perspective of Melvin Capital. Gabriel Plotkin, the founder worked at Citadel, the all powerful hedge fund that wears the black hat in so many of these stories. He set out on his own (after a somewhat eventful time at S.A.C. Capital Advisors), founding Melvin Capital and meeting with early success and high returns. A recent successful trade was shorting CD Projekt, correctly identifying an over-enthusiastic valuation for the company that had a considerable payoff with the troubled launch of Cyberpunk 2077. By any measure this is a sophisticated and successful firm that understands how to navigate financial markets. We don’t know what price Melvin Capital shorted GameStop at but there is every reason to believe it was as well researched and as sound as any of the previous successful investments the hedge fund had made. And yet a speculative bubble, totally independent of the underlying value of the company, specifically targeting their investment strategy and backed by a mob that would make them the poster boy for wall street hubris can deliver crushing losses that require their former boss and another investor to put nearly $3 billion into the company. The lesson here should be how hard it is to make money in the stock market.

You completely own your effort and your work ethic. I value financial markets. Financial markets let me take on debt in order to finance my education. I did so because I knew that I could pay that money back with earnings that were higher than if I had worked and saved to go to school instead. I am still paying off those loans. Do I wish they could vanish so I could have more discretionary income? Of course. But not so much so that if I were given access to a wealthy bank account with the certainty that the transfer would be unpunished that I would take the money to pay off those debts.

My view may be shaped by an experience I had in Vancouver. When going to an ATM at my bank I saw that someone had left the statement printout face up in a prominent place on the machine. The account had a balance that I have only ever seen exceeded once (and only when working at that bank). All that I could take away from that statement though was that my opinion, a complete stranger that the individual could only ever know in the abstract, mattered a great deal. I didn’t really register the wealth. Other people’s wealth isn’t that hard to find in downtown Vancouver. It seems that amount of money did nothing to tranquilize whatever nagging thoughts led them to leave that paper there for someone else to see, and I was the one who had something they wanted.

There are lots of foolish things people do over money, from leaving a bank statement out for a stranger to see to believing a speculative bubble wrapped up the language of protest is a sensible path to financial independence. If the current mania is to serve any purpose, let it remind us of how difficult it is to think straight when money is involved and use it as a chance to refocus on what truly matters both regarding regulation and our own work ethic.

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