How a number of couch investors ruined some Wall Street guys using a mobile app. And why the Wall Street guys really don’t care. And what it means for the future.

Hello and welcome to the first of two episodes of The Private Citizen for this week. This first episode, released in the regular Wednesday windows, will be covering a topic in detail as usual. The second episode, which will be released on Friday – the one year anniversary of this podcast – will be a special episode, in which I answer questions from the producers of the podcast. I’ve collected some ask-me-anything (AMA) style questions in our Discord server for this purpose and will answer them live on the show.

But first, let’s get to today’s topic at hand: GameStop. If you want to see me record the show live, here’s video on YouTube (Part 1, Part 2).

The GameStop Short Squeeze

So what in the world happened with GameStop? I will do my best to explain this, but keep in mind that stock markets are very far from my strong suit and that I never would give any financial advice (nor should you follow it if I did). But I will do my best to explain what happened and where reporting on this topic in the traditional media failed.

Wikipedia currently sums up the situation as follows:

In January 2021, a short squeeze of the stock of the American video game retailer GameStop (NYSE: GME) and other securities took place, causing major financial consequences for certain hedge funds and large losses for short sellers. Approximately 140 percent of GameStop shares had been sold short, and the rush to buy shares to cover those positions as the price rose caused it to rise even further. The short squeeze was initially and primarily triggered by users of the subreddit r/wallstreetbets, an Internet forum on the social news website Reddit. At its height, the short squeeze caused the retailer’s stock price to reach a pre-market value of over US$500 per share, nearly 200 times the stock’s one-year low of $2.57. Many other heavily shorted securities also saw price increases.

On January 28, multiple brokerages, including Robinhood, halted the buying of GameStop and other securities, later citing their inability to post sufficient collateral at clearing houses to execute their clients' orders. This decision attracted criticism and accusations of market manipulation from prominent politicians and businesspeople from across the political spectrum, and dozens of class action lawsuits were filed against Robinhood in U.S. courts. In reaction to brokerages halting the buying of GameStop and other securities, the total market capitalization of cryptocurrencies and metal futures increased.

GME Price Development

GameStop’s stock (GME) price development in January 2021

Now, Wall Street Bets has been around for ages. They got interested in GameStop because this kind of analysis is what they do and it being Reddit, many of these people are gamers and thus interested in companies that deal with video games.

The community is known for discussion around high-risk stock transactions. Even before the short squeeze, there had been interest in GameStop. Keith Gill, known by the Reddit username “DeepFuckingValue” and the YouTube and Twitter alias “Roaring Kitty”, purchased around $53,000 in call options on GameStop’s stock in 2019 and saw his position rise to a value of $48 million by January 27, 2021. Gill, a 34-year-old marketing professional and Chartered Financial Analyst (CFA) from Massachusetts, stated that he began investing in GameStop during the summer of 2019, after believing the stock to be undervalued. He shared information, as DeepFuckingValue, regarding his investment on the subreddit r/wallstreetbets, providing regular updates on the investment’s performance, including times when the investment had plunged. He stated on January 29, after the GameStop short squeeze, that he “thought this trade would be successful” but “never expected what [had] happened over the last week”, adding that he planned to continue his YouTube channel as Roaring Kitty and potentially buy a house.

DeepFuckingValue explained his position before the short squeeze like this:

Dude everyone thinks I’m crazy, and I think everyone else is crazy. I’ve dealt in deep value stocks for years but have never endured bearish sentiment this heavy. I expect the narrative to shift in the second half of the year when investors start looking for ways to play the console refresh and they begin to see what I see.

I’ll post the update tomorrow as I always do after data readouts. It will be ugly, and everyone will mock me as usual, but I expect GME to bounce back just as it did after the two previous earnings readouts.

There were other people who believed GameStop was undervalued.

GameStop, an American chain of brick-and-mortar video game stores, had struggled in recent years due to competition from digital distribution services, as well as the economic effects of the COVID-19 pandemic, which reduced the number of people who shopped in-person. As a result, GameStop’s stock price declined, leading many institutional investors to short sell the stock. However, in September 2020, Ryan Cohen (the former CEO of online pet-food retailer Chewy) revealed a significant investment in GameStop and joined the company’s board, leading some to believe that the stock was undervalued.

Meanwhile, the Wall Street Bets subreddit blew up. They even hat to make it private for a bit because they were overwhealmed by so many people joining up.

On January 27, technology news website Mashable reported that the subreddit had broken pageview records due to the short squeeze, receiving 73 million pageviews in 24 hours. r/wallstreetbets was the fastest-growing subreddit – the community surged by more than 1.5 million users overnight (to a total of 6 million members) on January 29.

What is Short Selling?

Again, from Wikipedia:

Short selling is a finance practice in which an investor, known as the short-seller, borrows shares and immediately sells them, hoping to buy them back later (“covering”) at a lower price, return the borrowed shares (plus interest) to the lender and profit off the difference. The practice carries an unlimited risk of losses, because there is no inherent limit to how high a stock’s price can rise. This is in contrast with taking a long position (simply owning the stock), where the investor’s loss is limited to the cost of their initial investment.

Short sellers are exposed to a risk of short squeezing, which occurs when the shorted stock jumps in value due, for instance, to a sudden piece of favorable news. Short sellers are then forced to buy back the stock they had initially sold, in an effort to keep their losses from mounting. Purchasing the stock to cover their short positions raises the price of the shorted stock, thus triggering more short sellers to cover their positions by buying the stock. This can result in a cascade of stock purchases and an even bigger jump of the share price.

I’ve discussed some of the positive aspects of short selling in episode 26 of the podcast.

Why were GameStop short sellers subsequently targeted by a large number of people on Wall Street Bets?

On January 22, 2021, approximately 140 percent of GameStop’s public float (the portion of shares of a corporation that are in the hands of public investors) had been sold short, meaning some shorted shares had been re-lent and shorted again. Observers congregating around r/wallstreetbets believed the company was being significantly undervalued, and with such a large amount of the shares being short they could trigger a short squeeze, by driving up the price to the point where short sellers had to capitulate and cover their positions at large losses.

This was in large part to a hostile sentiment against short sellers, and especially hedge funds, in general and also due to a dislike of people betting against a brick-and-mortar gaming retailer. Some people on Reddit seem to have understood this as an attack against the gaming community.

Or, as Wikipedia sums it up:

Due to the COVID-19 pandemic, consumer spending in general was drastically lower than normal. There was also more money in the hands of investors as a result of historically low interest rates and an inability to spend their money elsewhere. Other suggested factors included a culture of taking massive gambles on the stock market in the hopes of making money quickly, anger of some investors towards Wall Street hedge funds for their role in the financial crisis of 2007 and 2008, or the general democratization of the stock market coupled with the ability of retail traders to communicate instantaneously through social media.

Rudy from Alpha Investments, my favourite crazy internet millionaire and Magic-hoarding madman, who’s been a member of Wall Street Bets for ages, explains it all quite well in this video:

Further Reading

My newsletter article on this topic

Twitter thread from Josh Gross explaining more on the background of how this happened

Suck It, Wall Street – Matt Taibi on the whole situation

The Role of Robinhood and Other Day Trading Apps

There are suggestions that this wasn’t the “upitty little guys vs. evil corpo-rats” story that everyone makes it out to be, however:

I’m finding these posts about GameStop suggesting that somehow Reddit owned Wall Street to be sad. Reddit triggered a big Wall Street firm to crash. But, another Wall Street firm, Citadel, made money on all sides of it. Citadel handles most of Robinhood’s transactions, so they made money from every day trader who bought up GameStop, and will make money when they sell. Meanwhile, Citadel bought Melvin, the hedge fund that crashed, so they got a bunch of assets at a big discount.

These scum have a couple centuries lead on you, guys. It’s a nice story to think a bunch of nerds defeated Wall Street by day trading with their computers, but that’s a false narrative. the scum were ready to profit from it, and they did. All you did was help them discover which assets were distressed.

I’m all for sticking it to Wall Street and would love to see that happen for real. But you have to be honest and clear eyed to get there, in my opinion.

Robinhood and similar day trading apps made the whole story possible because they enable a whole new way for retail investors to buy and sell stocks from the comfort of their couch. Amidst the whole kerfuffle, Robinhood started preventing its users from buying or selling the GME stock, which drew harsh criticism, including from Elon Musk:

On Monday, Robinhood CEO and co-founder Vlad Tenev was questioned by Musk in an impromptu interview on the audio chat app Clubhouse in which he acknowledged that the initial ban on the platform’s users buying the shares was a “bad outcome”, however, he refuted claims that hedge funds suffering heavy losses during the episode had pressured the platform into limiting trades, saying instead that the company “had to conform” to its working capital requirements which were put under pressure by the unexpected upsurge in buying activity.

Despite the refutation, Tenev said a greater level of transparency was needed to explain how brokers calculate deposit requirements, a requirement for platforms such as Robinhood due to delays between user investments and actual security purchases.

The CEO described how the platform received an unusually large deposit request of around US$3bn from its clearing agency before the opening of the US stock market last Thursday, the same day it attracted fury from retail traders by blocking purchases of shares in GameStop as well as cinema chain AMC Entertainment Holdings Inc (NYSE:AMC). The influx of investor orders also forced Robinhood to raise US$1bn in emergency funding last week to shore up its platform, while the company also announced on Monday night that it had raised another US$2.4bn to meet the surge in user growth.

The Aftermath

Currently, GameStop stock is falling rapidly.

Shares in GameStop plunged by 65% in early trading on Wall Street as the trading mania sparked by small investors, that sent its stock surging and cost hedge funds billions of dollars, lost momentum.

The struggling Texas-based video game store chain has been the focal point of a battle by small traders, using forums such as Reddit, to punish Wall Street hedge funds that have bet on certain stocks falling in value. GameStop shares hit a high of $482 last Thursday but slumped to $80 shortly after the market opened. They recovered to $117 by mid-session, but closed down 60% at $90.

A year ago, shares in the 37-year-old chain, which plans to close 450 stores this year, were changing hands at $3.25 a share.

Because traditional media outlets may understand Wall Street, but not Reddit, the potential of these day trading apps or gaming culture, they were puzzled by this whole scenario. So it was quickly compared to Occupy Wall Street, blamed on Trump supporters and those pesky internet trolls who are basically all Nazis anyway.

Politicians, of course, tended to blame whoever they hate the most anyway. With AOC blaming capitalism itself, Elizabeth Warren blaming Wall Street as a whole and many Republican commentators blaming the internet and them new-fangled day trading apps.

But with this being 2021 and the culture wars being in full swing, the first instinct of many was, of course, to regulate and censor small investors.

Discord was the first to act, shutting down the WSB server sometime around 6pm. In a statement provided to the press, the social media service said the WSB Discord server “has been on our Trust & Safety team’s radar for some time due to occasional content that violates our Community Guidelines, including hate speech, glorifying violence, and spreading misinformation. Over the past few months, we have issued multiple warnings to the server admin.”

The statement goes on to specifically clarify that the move was not “due to financial fraud related to GameStop or other stocks. Discord welcomes a broad variety of personal finance discussions, from investment clubs and day traders to college students and professional financial advisors.”

WSB mods were also quick to dispute Discord’s banning decision, saying that “if you gather 250k people in one spot someone is going to say something that makes you look bad… We blocked all bad words with a bot, which should be enough, but apparently if someone can say a bad word with weird unicode icelandic characters and someone can screenshot it, you don’t get to hang out with your friends anymore.”

Producer Feedback

funkyduck commented on last week’s episode and suggested I’d do an episode on net neutrality. I’ve talked about this a lot in the past on other podcasts, but maybe I need to revisit it at some point.

An anonymous producer working in the automotive industry also comments on last week’s episode:

First of all, thank you for the information about the way car manufacturers are avoiding the regulation by not registering “new” vehicle types. The applicable term here is probably “facelift”. Initially it was a surprise to me why so many new projects are facelifts, this could be the reason behind that. As a second point, while discussing the topic, you mentioned that cars now have things like computers in them: the technical term here is ECU.

And as far as regulations go, on one hand, car manufacturers are required by law to satisfy the regulations. So in some case, you can say that they are the victim here. Because satisfying regulations have a non-negligible cost. Of course, it could be that some companies are somehow contributing to the establishment of these regulations, and of course they help draft them by contributing to committees. But this is the world we live in, and sometimes this complex mechanisms is what is brining the food to some tables, and fattening the pockets for others.

I also got a lot of other email I can’t publicly talk about on the show. But I wanted to mention it and thank people publicly for sending me things.

If you have any thoughts on the things discussed in this or previous episodes, please feel free to contact me.

Toss a Coin to Your Podcaster

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Thanks and Credits

I like to credit everyone who’s helped with any aspect of this production and thus became a part of the show.

Aside from the people who have provided feedback and research and are credited as such above, I’m thankful to Raúl Cabezalí, who composed and recorded the show’s theme, a song called Acoustic Routes. I am also thankful to Bytemark, who are providing the hosting for this episode’s audio file.

But above all, I’d like to thank the following people, who have supported this episode through Patreon or PayPal and thus keep this show on the air: Michael Mullan-Jensen, Dave, Jonathan M. Hethey, Butterbeans, Georges, Steve Hoos, Mark Holland, Shelby Cruver, Jackie Plage, Philip Klostermann, 1i11g, Jaroslav Lichtblau, Kai Siers, Fadi Mansour, ikn, Dirk Dede, Matt Jelliman, Joe Poser, Michael Small, David Potter, Mika, Martin, Dave Umrysh, S.J., RikyM, drivezero, MrAmish, Jonathan Edwards, Barry Williams, Larry Glock, Bennett Piater, avis, Neil, Captain Egghead, Christoph Martin and Filipe Carvalho. Many thanks to Twitch subscribers as well: Mike_TheDane, jasonw3rt, Galteran, redeemerf, indiegameiacs and Andyp4nts.

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