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Games of the Stock Market

The month of January in 2021 saw a strange and unprecedented turmoil in the US stock exchange market. This was highly noticeable in the stock price of the company Gamestop, as well as that of Blackberry, Nokia, and AMC Entertainment.  The stocks of Gamestop showed the greatest volatility of all time and grabbed a lot of media attention. The company is an American brick-and-mortar retail chain of video games and video game merchandise, with more than 5000 stores in the USA. It was showing signs of decline, in the face of competition from online gaming platforms like Playstation and Xbox. Due to the coronavirus crisis, it had announced plans to shut down 1000 stores, and it was looking to be going in the way of Blockbuster.

Its share price was $17.25 on the 4th of January, 2021. But then, the share price reached its peak at $483.00; an increase of 2700%, even though in August 2020, its share price had gone below $5. So how did this sudden upsurge in prices happen?

GameStop share price since January

The key to this mystery lies in the functioning of the stock market, specifically an operation known as shorting the stock of a company. The stock market is a way to bet on the share prices of listed companies and make money or lose money off those bets. Shorting a stock is simply betting that the prices of that particular stock will go down. If your bet pays off, you stand to make a lot of money from that. How does this all work? 

You can borrow shares of a company, whose price you expect will fall, from a stock market broker and sell it on the open market at the prevailing share price of say $20. Now after the prices have fallen to a certain level like $15, you buy it at the open market and return it to the broker. Thus you make a profit off the difference in share prices, which is $5. But if the share prices start going up, then you’re in trouble. At some point, you will have to buy the stocks on the market to return to the broker, and if you buy it at a price of more than $20, you will make a loss of whatever amount you pay more than $20. From this example, it is clear that the maximum profit you can gain when the share price drops is $20, but there is no limit to how much you can potentially lose if the share price rises. So it is mostly big financial institutions on Wall Street like hedge funds and investment firms who take the risk and short stocks. Non-experts like day traders don’t venture into this territory.

Apart from the risks, there are also genuine questions about the ethics of short selling. The market works on signals and when many big institutions start to short a stock the share prices tend to go down. So financial institutions are often betting on the failure of businesses when it comes to shorting and making money on that failure. It is also possible that a large company shorts a smaller competitor and forces it into bankruptcy. But on the other hand, it is also useful for price discovery and detecting fraud. If there truly is a bad company that is making false claims to the public, like Theranos, then betting against it can help to fund research into such fraudulent companies.

Wall Street financial firms, like the investment management fund Melvin Capital, shorted GameStop stocks in the hope that their value will fall to zero. They did this on a massive scale and it was even rumored that they had borrowed more shares than there were in the market. This information was posted on the subreddit r/wallstreetbets, which is a community of millennial investors mostly comprising of regular people who use their own money to buy stocks via investment apps like Robinhood. In this situation, the members of the subreddit decided to go on a massive buying spree of GameStop stock, pushing the prices to unheralded heights. This resulted in astounding losses to these hedge funds and investment firms. Melvin Capital had to purchase the shares at the now-higher market price to return to the lender, taking a huge loss in the process. As a result of this, its valuation decreased by 30% and it had to raise 3 billion dollars in capital to survive. It was reported that short-sellers lost a total of 6 billion dollars due to this.

Robinhood was founded by Silicon Valley and Wall Street investors aiming to ‘democratize’ finance, that is to provide common people with the opportunity to make bets on the market. When the situation created by the subreddit became extremely dire, Robinhood stopped allowing users to buy GameStop shares and other similar stocks pumped up by r/wallstreetbets like Blackberry, Nokia, and AMC Entertainment. They could still sell their shares, but buying more wasn’t allowed. This resulted in GameStop share prices dropping by 40% and a lot of Robinhood users suffering losses. They have now initiated a class action lawsuit for manipulating the market against its customers. 

This whole episode has created a narrative of the common people standing up to the entrenched financial institutions of Wall Street and exercising some of the power that is usually only available to the select elites of the financial world. It is seen as a manifestation of the current anti-establishment wave going around the world against the rising levels of inequality and injustice. It is part of the anger felt at Wall Street firms escaping largely unscathed after the 2008 financial crisis which left so many common people facing destitution. 

Firms like the ones on Wall-Street have always maintained the belief that the stock market is a fair reflection of the state of the economy, and share prices are correct representations of the health of a firm. It is an environment that has given rise to a company like Tesla, which is yet to make a profit but has a valuation of 750 billion dollars, making Elon Musk the richest man in the world. The total worth of financial assets in the world today is at an all-time high, at nearly ten times the total value of goods and services produced in the world. The common people can only earn the money they get in exchange for their goods and services. This means that the majority of the people in the world don’t have access to these financial markets, and this points to a very high level of inequality as well as a lack of equal opportunity in our society. Venture capitalists and investment firms have always taken advantage of grey areas of the financial world and manipulated the murky waters of this world of speculation.

In the backdrop of such a situation, the GameStop episode has been a stirring tale of David vs Goliath — a story of democratization of finance. It is a rousing narrative of the common people banding together and taking on Wall Street at its own game and gaining an unprecedented victory. 

But is that all there is to it? Is this the beginning of greater accessibility of financial markets to the common masses? Can the individual voices unite to influence the forces of the market sufficiently to have a significant impact? On closer examination, this narrative begins to fall apart. The big financial institutions own 80% of the stocks available of the companies on the S&P 500 index. So even if all the individual investors teamed up they would never be able to have a lasting impact on established Wall Street institutions. 

Apart from this, Robinhood, the platform which provides the common people with easy access to credit to speculate on the stock market, is itself owned by a team of Silicon Valley and Wall Street investors promising to democratize finance. Their business model is based on monetizing the information they’re getting on what stocks their customers are buying. This way they can understand which way the market is going to go and thus capitalize on this information. The main institutional investor behind Robinhood is Citadel Securities, an American hedge fund that is also a direct competitor to other hedge funds like Melvin Capital. Citadel Securities was able to make a profit from the information of their customers, but the competitors of Citadel who bet against GameStop were the ones who lost out heavily. It was Citadel that was able to buy the shares of Melvin Capital to keep it afloat, and in the process, become more powerful.
In the aftermath of this episode, the share price of GameStop has stabilized at around the $50 mark. It is also coming to light that a lot of institutional investors made substantial profits from the market activity around GameStop. The high volatility attracted the scrutiny of the government, which is reportedly examining the need for new regulations in this age of great influence of social media. So it is possible that something of this nature might never occur again. Maybe this wasn’t even the David vs Goliath narrative that it was made out to be. But it was a story which inspired hope of decentralisation of power to the people and it gave a peek at the possibilities of how social media can unite people for good.

Shikhar Rana is a first year Masters students of Economics at Ashoka University.

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