The world is indeed a strange place. These days, it seems like anything can happen. In early 2021, a viral battle erupted in the most unlikely of places, the stock market. It was publicized as a conflict between investors on the Internet and large hedge funds. But what's the full story, and what consequences will we see?
It all started in September of 2019 when an armchair investor by the name of Keith Gill noticed something interesting in the stock market. He sat down at his computer, signed into YouTube, and started talking about what he saw. Keith also took to Reddit and would start posting about his observations. Most of the people in the forum laughed at him, but Keith believed that the payoff would be huge. Nobody at the time understood what he was doing, but his decision would set in motion one of the most insane moments in financial history. It would bring multibillion dollar hedge funds to their knees and spark a social uprising between the public and Wall Street. Sit back and relax as we uncover the story of how one Reddit user kicked off a revolution that rocked the financial world.
In the year 2000, Bill Clinton signed the Commodity Futures Modernization Act and ushered in the age of financialisation. Without much hesitation, the financial sector began to have an increasing influence over the overall economy. Instead of producing goods or services, large sectors of the economy became dedicated to engineering creative ways to make money with money. Bill Clinton later admitted that he'd made a huge mistake, but it was far too late. The floodgates for market speculation were opened. Evermore exotic financial products were invented and sold. The banks and financial players were supposed to regulate themselves, but this didn't happen. Financial products would be traded privately, without supervision. There was no connection to any real-world underlying asset. However, the risks they created in the financial system were real. The speculation finally got out of control in 2008, causing a crisis in the global financial system. There were millions of bailouts for the banks and hedge funds, while millions of ordinary people lost their jobs. Work became scarce and many struggled to provide for their families. As the dust settled, the anger grew, and in 2011 it erupted into a movement called Occupy Wall Street. Its purpose was to protest against the bankers and show that they couldn't get away with gambling with other people's money. But something strange happened. Within a year. It seemed that everyone lost focus on the financial issue, and instead of challenging the banks and holding them to account, society began to fight one another over their personal differences. Meanwhile, the financial institutions could breathe a sigh of relief at the turn of events.
Fast forward to 2020 and a global pandemic would trigger lockdowns around the world. In the United States, about 47% of jobs come from small businesses, so naturally, shutting down the economy spelled economic devastation. With people out of work and many growing restless with their situation, they began to notice something. While their businesses were shut down and their jobs gone, it seemed that Amazon, Walmart, and other massive corporations were just fine. In fact, there were thriving. Not only this, but the financial markets began to boom. The rich were once again getting richer while they lost everything. Wealth was being extracted from the little guy to the financialized economy. With jobs gone, nothing to do, and only limited government support in the form of stimulus checks, the stage was set for a revolution against the financial institutions. In 2012, thirty year old Jamie Rogozinski would browse a forum called Reddit from time to time. He had made some extra cash at the time while working in Washington DC, So Jamie had the idea to gather a community around investing. He would start a subreddit called Wall Street bets in order to do this. For the first few years, the Wall Street Bets Forum only managed a few 1000 users. Then in 2019, some brokerage giants eliminated trading commissions for their apps. They made trading free and accessible. In a moment, retail investing exploded onto the scene. The number of Wall Street bets subscribers quickly grew past 500,000, then 1,000,000 during the crash of March 2020. By this time the community had taken on a mind of its own. Jamie, the original forms creator, voiced his concerns that it was spiralling out of control and deleted some moderators as he saw fit. He was met with backlash and was ejected by other moderators. This was now bigger than Jamie. In a statement the Wall Street Journal, he noted that Wall Street bets is no longer what it used to be. While all of this was going on, a user in the Wall Street Bets Forum by the name of Keith Gill was keenly studying something he'd noticed. On his YouTube channel, the armchair investor Keith Gill laid out his game plan. It was to buy some stock of a company called GameStop, an unassuming store founded in 1984 and familiar to most people in the United States, GameStop had a simple business model to sell video games and gaming equipment out of its physical store locations. Naturally, this model became less lucrative as more gamers moved to online purchases. It seemed that GameStop was on the ropes of facing bankruptcy. So why did Keith? Want to buy such a company? Well, he thought that this view was overblown. Although the company was closing stores by looking at their ten key quarterly financial reports, they actually had a lot of cash and could pay off their debts and the company could recover just with some good management. On his YouTube channel, Keith would prove his points with evidence he was reading blogs, press releases Seeking Alpha articles, company notes and more, all to make his case that the stock was actually undervalued. For example, he knew that new gaming consoles were coming out soon, and this would be great for GameStop sales. He also theorized that the move to digital was actually a lot slower than people were thinking, and this would be important for the company. Over the next couple of years, he pulled up articles and videos of people talking about physical game disc versus digital downloads.
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He realized that there was still a lot of demand for physical games, which meant even more revenue for GameStop. He was diligent and left no stone unturned to make his case. He invested $53,000 in GameStop in September. This was 2018-2019, 2020 right now and the trend is clearly going toward digital. But this is my point is that you're still seeing some countries that are still heavily skewed to physical and I don't think. One year later, all of a sudden everyone's going to be buying digital. I just need to make sure that GameStop isn't going bankrupt in that people are still buying discs, and that there are still demands for GameStop for just a couple of years. Because if that's the case. GameStop is likely undervalued.
A small number of Redditors also agreed with cave. But then they noticed something even more peculiar. 84% of GameStop stock was held as short positions. That is, betting that the price would fall. This was highly unusual. It turned out that hedge funds had colluded in selling short the stock, publicly stating that the price would go down, therefore making the millions. They sold over 130% of the GameStop stock short. At this moment, the Redditors had a unique opportunity in financial history. A populist financial movement could be hatched if played right. But first, to fully understand the game plan, we need to 1st describe what short selling is. Say you borrow some vintage baseball cards from a friend for about $400.00, but promised to give the cards back to him next week after he agrees to give you the baseball cards. You sell those same cards to a dealer for $400.00 because that's the market price of the cards. You do this because you expect the price to drop. Say in one week's time, the market price of the baseball cards drops to $300. You bought the baseball cards back from the dealer at the new price of 300. Since you originally sold it to the dealer for 400, you now have $100 leftover. After this you returned the cards to your friend. That's basically short selling, except you have to pay interest to your friend for borrowing the cards. Now here's the clincher. If after a week the market price of the cards was to rise to $500.00, then you'd be out of pocket $100 by the time you give the cards back to your friend. But The thing is, if the price of the cards keeps rising and say that there's lots of people that are in the same position as yourself, they'll all want to buy their cars back from their dealers and sell them back to their friends to limit their losses. But the action of a mass buying of cards actually raises the market price of the cards. This is called a short squeeze.
That last scenario is what happened to these hedge funds. In essence which short selling the losses are almost limitless. I think the hedge funds are the dumb money. Right. Every experienced hedge fund manager knows you do not short a stock with 138% short interest in terms of risk and reward, which is what investing is. The retail guy nailed this. So the hedge funds overstayed their welcome in these shorts.
So back to GameStop. The fatal mistake the hedge funds made is that they were greedy. They could have rode the GameStop stock down from $50.00 and bought it back at $5.00, but they hung in there without selling, seemingly because they wanted every last cent from their bet. It seems like they were just waiting for GameStop to go bankrupt. Unfortunately for the hedge funds, this left themselves exposed and wide open for an attack. Their expectation was that would be driven to zero and they would never have to buy the shares back. They got greedy even though it was down to four or three. $2 I think 250 or something. At one point they just kept holding their position as opposed to buying it back, closing out the position at and and not risking the extra couple bucks per share and it backfired. While Keith was posting about his findings, another Reddit forum user posted A7 point document titled quote, Bankrupting Institutional Investors for Dummies featuring GameStop. The user pointed out that hedge funds were fatally exposed. The Wall Street Bets Forum love the idea. It was brilliant. The risk to the Redditors was limited. The worst that could happen is that the stock goes to zero and they lose all their money. On the other hand, the risk to the hedge funds was immense. The hedge funds could lose more money than they put in, and worse still, they had borrowed money to short sell. The plan was for the Reddit army to keep buying GameStop stock, driving up the price and making the hedge funds lose more and more money. The hedge funds would be forced to abandon their positions and cover their losses by buying shares from the market to return to their lenders. And like our baseball card example earlier, this very act drives up the prices even more. It was a cascading event, leading to a dramatic rise in the stock price. In a very short time period it was almost like a bug in a video game being exploited. As the stock kept rising and the hedge funds kept losing money, Reddit realised that they could bring the hedge fund to their knees. It was a digital form of protest. The masses were playing the banks and hedge funds own game against them.
By January 26th, GameStop was the single most traded stock in the US stock market, with volumes matching that of the five biggest tech giants combined. GameStop saw its share price spike from just a few dollars and 2020 to a peak of over $490.00, transforming a firm that was valued at less than 200,000,000 in April 2020 into a company worth more than 28 billion. Buzz began to build around the story, and the news media ran with the narrative of the people taking back control by playing the game of the bankers against them. But as you'll soon see, there may be more to the story.
By the 28th of January the hedge funds and short sellers had lost $70 billion and 5000US firms had been affected. It was all out war.
As news of the GameStop rebellion spread around the world, billboards began to appear, telling the public what to do buy.
On the 28th of January, a small physical protest occurred on Wall Street itself. Meanwhile, online Redditors encouraged each other to hold strong and not to sell, no matter what a term that they called Diamond hands. The plan was the longer the Redditors held out, the more damage they would do to the hedge funds. This would be in the order of millions and possibly billions of dollars due to the large amounts of interest they had to pay. The news soon reached the White House. While this was happening, the big shocks sensed an opportunity. Larger trading professionals joined the fight, but only for their own profit. BlackRock and eight other Wall Street Titans made a combined $16 billion on game stock in a matter of days. You see, it wasn't just the redditors that made money. And that's the key point in this story. Wall Street always finds a way to win. Redditors noticed that more companies in bad shape were also being heavily shorted. This included Nokia, AMC Movie Theatres and more. Other coordinated attacks were made to bid up these prices too, and it seemed to be working. Melvin Capital, a heavy short seller, was a large casualty. They had to be bailed out to the tune of $2.7 billion by Citadel, another hedge fund, and this was according to Bloomberg.
Meanwhile, 3 of Gamestop's biggest investors gained over $2 billion in personal wealth from the frenzy. Other small traders were now able to pay back student loans. Another subreddit called Wall Street bets gives back donated their earnings to charities and organisations. As for our armchair investor Keith Gill, who had only invested around $53,000 back in 2019, his bet on GameStop had now turned into a fortune of $48 million at the height of the stock rally. But it wouldn't be smooth sailing for him and many others. Battle lines soon began to be drawn. Discord stepped in and banned communication between the redditors on their platform, citing hate speech. But it only fueled the fire. The Wall Street Bets Forum on Reddit would grow from 5,000,000 subscribers to 8 million in a couple of days. Facebook was next to step in and banned the Robin Hood trading group with over 157,000 members. The popular trading app Robin Hood made its number one on the App Store before banning retailers from buying GameStop stock. Nokia, AMC and other stocks are also included in the ban. Only selling was allowed. The actions by Robin Hood enraged the general public, who was by now fully aware of the situation. Multiple class action lawsuits were launched and politicians and celebrities alike got involved.
Blocking people from buying stocks and only letting them sell would be pushing the price down artificially. This could have been perceived as a form of market manipulation. The perception was that Robin Hood was siding with the large hedge funds as they do receive funding from Citadel and others. In return, the hedge funds get massive amounts of data from the small investors, and from that they can figure out how to make money. In fact, Robin Hood has made $700 million in selling user data to hedge funds. During all of this, an SEC investigation was also triggered. In his company's defence, according to CEO Vlad Tenev, because of the unprecedented market conditions, Robin Hood was forced to raise $1 billion to keep things running. This all raises questions. If this chaos hit Robin Hood from just a few stocks, what would happen if there was widespread volatility across the whole market? As February rolled around, the sentiment changed. The game stock price began to drop and fear spread throughout the Reddit message boards. Some users had lost hundreds of thousands and some millions. Keith Gill had now lost over 14 million, but they all held their position. They believed that the hedge funds would have to buy back their positions to cover their shorts sooner or later, and this would cause the price to rise once again. Though it is possible that although the Redditors held, the big Sharks had already sold. I can commend the Redditors for their strong conviction in doing what they believe was right, but many have broken the number one rule of investing only invest what you're willing to lose. Though maybe some view it as a donation to a good cause rather than an investment. As the stock price began to wane, a new new cycle began to emerge. The Redditors had moved from GameStop onto silver. Many physical silver dealers saw a massive increase in demand and the silver price shot up, but this outcome was not possible by Reddit alone. The silver market is too large and even the Redditors knew this. There were many posts on the forums saying stay away from silver is just a distraction from GameStop.
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The consensus on the forum was that the news media was lying and they were the ones causing the rush to silver.
This broke the trust in media for many that understood what was going on. By this stage, the Wall Street bets forums were on fire. There are reports of large institutions failing to deliver borrowed GameStop stock and hedge funds using a technique called a short ladder attack. This is where hedge funds sell 100 share increments back and forth to each other in order to drop the price. The rumor mills were swirling and it became almost impossible to truly determine what was happening. There will no doubt be more calls for regulation. In a CNBC interview, NASDAQ CEO Adena Friedman called for the monitoring of social media chatter to stamp out coordinated stock moves. " I think that in general when we evaluate how we would manage through a situation where you see a significant run up in a stock with that's not based on news, that's not based on fundamentals. What we do is we do have technology that evaluates social media chatter and if we see a significant rise in the chatter on social media channels and then we also match that up against. The usual trading activity, we will potentially halt that stock," She says.
Robin Hood would slowly open up the buying of the targeted stocks, but not before Vlad was ordered to testify in front of Congress. Janet Yellen, formerly chairwoman of the Federal Reserve and current Treasury Secretary, is going to call a regulatory meeting over the GameStop Rebellion. Yellen has formally received over $700,000 in speaking fees from Citadel, making it a conflict of interest. She's currently seeking a waiver to conduct the hearing. The GameStop Rebellion has set a precedent. This is the very first instance of the intersection between social media and the financial system. The idea has since gone global. Bloomberg has reported the targeting of shorted stocks from Amsterdam to Sydney. In Europe, some of the most shorted stocks jumped 20% or more, and in Tokyo, short sold stocks jumped by about 7% or more. On another note, there could be implications for the wider market in the future. If another short squeeze was organised and a big firm was to blow up, it could end up being deemed too big to fail by the government and once again another taxpayer funded bailout could occur. This isn't to mention systemic risks. The financial system is completely entangled, complex and fragile. As hedge funds need capital to cover their shorts, this could cause some selling elsewhere.
Our trust in the financial system is at an all time low. Over 23% of all U.S. dollars in existence were printed last year. Meanwhile, 40% of Americans don't have $400.00 in the bank for emergency expenses. This is from the country that is the world reserve currency, so it has global implications. This story has revealed how volatile and detached from reality stocks can be these days. Low interest rates, stimulus, excessive financialization and quantitative easing has transformed the global economy from productive, innovative and earnings focused to a decaying husk of speculation and financial engineering. For years, companies were buying back their own stock so the price would go up and look good on paper. When the cost of borrowing money is cheap, no one cares about risk. The GameStop Rebellion was a wake up call. Average people aren't happy with this. They're saying you can't keep doing this to us. There's a great quote by Warren Buffett. "Price is what you pay, but value is what you get." The Wall Street bets crowd destroyed that relationship, but the twist is it could be argued that the relationship between price and value has been destroyed and manipulated all the way back since the Clinton days, when he ushered in the age of financialisation. January of 2021 marked a cultural shift in the way that the financial market is viewed. For the Reddit users that were fed up and just wanted change to happen, their objective may have already been achieved. People are once again talking about the unfairness of the financial system, but will the new regulations that stem from this shut down the little guy? That remains to be seen, but regardless, one day this story will be taught in business schools around the world, no matter the outcome. And that, my friends, is the story of how one guy on Reddit started a financial revolution. A story that's still unfolding.
Thanks for reading the whole article.
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