In the last few days, financial markets have watched with bated breath as users of the Reddit forum r/WallStreetBets engaged in a self-declared war against Wall Street. GameStop, a chronically underperforming video-game company which saw its stock stagnate between $4 and $6 a share for much of 2020 and whose valuation fell by over 90 percent in the last five years, suddenly found itself a Fortune 500 company worth over $23 billion. The sudden increase was a stunning display of stock market volatility and the inability of the free market to accurately regulate company worth. This stock surge comes after multiple investment firms shorted the company for more than 140 percent of its float. While mainstream media have decried retail investors for engaging in price manipulation and collusion, the counter-establishment have pointed out the hypocrisy by explaining how professional investors participate in similarly underhanded dealings. Although the tale certainly makes for a satisfying underdog story, it is hardly as punitive of financial investors as some may expect. In exchange for transferring wealth from the hands of one investment firm to another, all the Reddit users have gained is a sense of schadenfreude and some financial risk.
Short-selling occurs when investors decide that the price of a stock—or, if an analogy helps, let’s say the price of gold—will fall in the near future. By borrowing some gold, selling it at the current market price, and then waiting for the price to fall, they can repurchase the gold once prices have fallen for a lower price and make a profit by returning the gold. However, when Reddit users realized that the short was happening, they decided to execute a short squeeze—in the context of our analogy, collectively purchasing gold so as to increase their price and force the investment firms to buy the gold back at a higher price than they sold it for. In this instance, this strategy has worked spectacularly; the ongoing price surge has cost investment firms like Citron Research and Melvin Capital losses of over 100 percent.
In response, many on Reddit have extolled the successful short squeeze as a victory against the capitalist elite. I, for one, do not agree. Over 75 percent of the stock is held by the top ten holders, meaning that the short squeeze ultimately does little more than facilitate a redistribution of wealth from the extremely wealthy to another group of the extremely wealthy. Although retail investors have come out of the skirmish feeling like the victors, the market volatility they are generating also poses an opportunity for larger investment firms. While some companies on Wall Street may have come off with a loss, others have profited from the sudden increase in trading volume. Take, for instance, the investment firm BlackRock: the 13.2 percent stake it acquired last December for $174 million has suddenly ballooned to $3.1 billion, which is hardly anyone’s idea of a decisive victory against the Wall Street elite. Moreover, the price of the stock is likely to fall eventually, given that the price never broke above $20 a share in 2020. Once investors start to turn their interests elsewhere, they will sell their shares and subsequently prompt others to do the same. When that happens, trading algorithms will allow larger investors to pull out early and leave retail investors to suffer the losses.
The capital reserves and trading algorithms investment firms have to fall back on make them much less likely to fail on the stock market. Even after sustaining a loss of more than 53 percent on its assets, Melvin Capital received a cash injection of $2.75 billion this Monday. By contrast, the average amateur investor who may have bought GameStop shares on margin (by borrowing from brokerages) would likely have pulled out long before then. Ultimately, the parties retail investors are trying to punish are the very same ones that are running the system. Firms like Citadel Securities, LLC, a hedge fund company partly responsible for bailing out Melvin Capital, rely on high-frequency trading for much of their revenue. Because all brokerages charge a commission fee for stock market transactions, they are the true winners of this misguided attack on investment firms. Should the members of r/WallStreetBets really wish to prevent Wall Street from making yet more money off of their misguided enthusiasm, perhaps they should have buried the money in their backyards instead.