• Thomas Neuburger

The GameStop Story

Updated: Feb 2

By Thomas Neuburger

By now most avid consumers of political news — meaning all of you — have been exposed to at least the headline version of the GameStop story. Most have not, however, been exposed to the whole story, all of its ins and outs.

For example, the story is most simply explained as "little investors" (the scruffy, basement-ridden reddit crowd in this case) vs. "Wall Street" (predatory hedge funds like Melvin Capital).

Most are only dimly aware of the intermediary players like Robinhood — some kind of broker used by the reddit people — and Citadel, whatever that is. So the story gets told as a two-handed game of poker instead of what it really is, a four-sided (or five-sided) game of chess.

Despite all that, it's really not hard to understand what happened, and what is still happening. In a nutshell here's why the major players are playing the GameStop game:

The reddit investors wanted — and still want — to take down a bunch of greedy, manipulative Wall Street hedge funds that hit their radar in the first place because they were a) way overleveraged and therefore vulnerable, and b) threatening a business the redditors had affection for, GameStop, a mall resale store for gamers. The redditors also wanted to make money doing it, and they saw a way to do both.

The predatory Wall Street hedge funds wanted to drive GameStop out of business by "shorting" the company's stock and cashing in for multiples of their initial investment when it crashed.

Robinhood is a brokerage company that, among other activities, offered free order-fulfillment services to individual investors — you read that right: no-commission sales. Robinhood wanted to pretend to be for the "little guy" while selling all the data they had on what the "little guy" wanted to buy, for a price, to...

Citadel Securities, a Wall Street firm owned by Ken Griffin, that was acting as Robinhood's house or order fulfillment operation. The reason Citadel was willing to pay Robinhood to fill its orders was simple — this allowed Citadel to buy the stock that Robinhood's customers had placed orders for, before they filled Robinhood's customer orders. They then sold the stock to Robinhood's customers — or on the open market if the stock rose enough — at a profit.

So, three (legal) cheaters and a gang of (possibly greedy) "scruffies."

A further complication is that other Wall Street entities were investing alongside the redditors, but we'll keep that out of the discussion for now.

The Endgame

Here's what the GameStop endgame — a place we haven't yet got as of this writing — looks like:

• The hedge funds will win if the scruffies decide to sell their stock (driving the price back down) before the hedge funds go broke on margin calls and losses. Why would the reddit "mob" sell their stock? To take profit, since for many of them GameStock shares have risen 1000% or more.

• The reddit group will win — at least with respect to the hedge funds — if they hold onto their stock, refusing to take profit long enough to bankrupt the hedge funds or at least inflict huge losses on them. Why would they hold on when so many of them are in profit? To force funds like Melvin Capital out of business as a kind of digital Occupy Wall Street rebellion.

• The hedge funds will also win if the Biden government, our fifth player, stops the game before they lose — with perhaps an added secret Wall Street bailout — as a way of protecting the finance industry members of its bipartisan donor class.

One of those three thing will occur. Melvin Capital has already lost 53% of its investors' money and has been forced to borrow $2 billion (from Citadel) to stay afloat, so we're getting close to a conclusion.

How did things get so bad for funds like Melvin Capital? Big-time speculators usually borrow stock they want to sell short rather than buy it outright since it ties up less capital to pay borrowing fees. But doing so puts them on the clock. At some point, those loans will have to be renewed or the stock returned to the lenders.

And to put icing on the cake, the percentage of GameStop stock loaned to funds like Melvin equaled more shares that the total number of shares in existence. At one point, 140% of all GameStop shares were loaned to hedge funds.

Where We Stand Today

As I write this, neither side has won:

The battle between retail investors and hedge funds burst seemingly out of nowhere last week, and many people are now spending the weekend wondering how it will end. The answer depends in part on two things: First, who will be first among the three group of actors — hedge funds shorting the handful of stocks, retail investors buying them and the intermediaries enabling both sides to trade — to surrender, especially if done through a disorderly unwinding of their book? Second, how will regulators and politicians react?

It's a giant game of chicken. Who will give in first?

If the reddit crowd (the "retail investors") just holds out, time is on their side. And Melvin Capital, one of the hedge funds most burdened by its GameStop short position, has already lost more than half of its investors' money. Other hedge funds who are playing the same game, and not just with GameStop stock, are also suffering.

My bet is on the Biden government rescuing Wall Street just as the Obama government did, then folding the GameStop story into the "populist-terrorist" story we're all getting used to.

The Whole GameStop Story in One Twitter Thread

The following is an excellent twitter thread by Cory Doctorow that lays out, step by step, almost all of what seems to have happened. It's quite readable — I'd give it a chance to hold your attention to the end. (Emphasis and other formatting changes are obviously mine.)

If you want more information, here's an excellent article by the always good Alexis Goldstein, an article Doctorow also recommends.

A thread by Cory Doctorow #BLM

There is no shortage of takes about what's going on with Gamestop (and other surging stocks), Robinhood and Reddit's r/wallstreetbets, many of them contradictory - at least on the face of them. But I think it's possible for most of these takes to be right. Here's how.

First you need to understand the underlying mechanics of the story. Stock markets are fundamentally a way of making bets, including bets on the outcome of other peoples' bets, and bets on the outcomes of THOSE bets.

All this complexity creates lots of exploitable opportunities. Some of these opportunities are considered legitimate and are given respectable names like "arbitrage." Others are considered illegitimate, and are called disreputable things like "stock manipulation."

A hypothetical Martian observing all this through a telescope could not tell you which kinds of bets were honest and which were dishonest, because the difference isn't about any objective standard, but rather, about power. The strategies of powerful people are legit, while the strategies of their would-be dethroners are not legit. Sometimes, even outright frauds are OK if they're done by people with enough power.

If your scam pays out quickly enough, you can sometimes parlay the resulting cash into retrospective legitimization, so even the strategies of the out-group can end up being retconned as legit, if they're successful enough.

That's why Amway isn't illegal: Betsy DeVos's father-in-law was simultaneously the boss of Amway and head of the US Chamber of Commerce, and Gerry Ford was his Congressman, who was then elevated to president in time to legalize its business model. To understand the Gamestop rise, you have to understand a couple of different kinds of bets.

"Shorting": this is a bet that a stock will go down. There's a complicated backstory to how you make this bet, but it doesn't matter.

The thing to know here is that shorting a stock can make you rich...if the stock goes down. But if the stock goes up, you lose money. There's not really any limit to how much you can lose here. Every time the stock goes up, the shorts have to pony up more money to keep their bet alive (in the hopes that it will go down again later), or they have to take their losses, pay out the winner of the bet and surrender any chance of winning later.

Shorting isn't just a bet on someone else's failure - it's a way to fund bullshit-detection. If you know (or suspect) that a company is lying about its prospects, you can bet against it.

Shorts fund a lot of research into defective products and scammy businesses, because they win when bad companies are exposed and their stocks go down. Some of the scary security research you read about bad IoT software is funded by shorts.

That's why habitual bullshitters like Elon Musk HATE shorts. Musk leads a cult of credulous worshippers who buy whatever he's selling. Shorts make bets that Musk's cultists will get deprogrammed. Musk uses this to sharpen his cultists' resolve: "they want us to fail!" "Options": many different bets get lumped in as "options" but for the purposes of this discussion, buying an option means buying the right to buy stocks later. The people who sell you the option usually go out and buy the stock right away so they'll have it to sell.

"Front-running": Cheating. Front-runners insert themselves into transactions by spying. If I know that Alice is buying a bunch of Bob's shares, I can snap them up a millisecond before Alice gets there, mark them up, and sell to Alice at a profit. "Retail investor": An "average joe" who buys stocks from a brokerage like Robinhood. "Institutional investor": Hedge funds, private equity funds, pension funds, index funds, investment banks, etc. Whales and sharks.

"High-frequency trader": A bot. Someone (usually an institutional investor) who uses an algorithm to buy and sell shares very quickly. HFTs might buy a stock and sell it less than a second later (when they're front-running, for example).

With that all out of the way, here's what seems to be going on. Reddit's r/wallstreetbets is a "retail investor" forum of average joes, many of them angry at the scammy, evil stuff that the big institutional investors get up to. Their grievances are mixed: some are angry that big investors have figured out how to destroy good businesses for money. Some are angry because ONLY big institutionals get in on the action when that happens and average joes are locked out of those plays.

They are stuck at home, have little to spend their money on, and - critically - have access to "trading platforms" like Robinhood that let them buy and sell stocks without any fees (institutionals often have sweetheart deals like this, but average joes used to pay to play).

They're getting together to make money and to punish their enemies. The easiest enemies to punish are shorts, because if they push up a stock even a little, the shorts get pounded for millions of dollars.

If they can keep the stock up long enough, the shorts will give up and the average joes will collect their winnings. And the average joes are clever. They've figured out that they don't even have to buy the stocks to force the price up - they can buy cheaper options instead.

An option is a bet. The people on the other side of the bet usually buy the stocks they sell options on. If I buy an option to buy a stock from you and then the stock goes up, you have to go out and buy the stock and sell it to me at a loss.

If you're an option seller who thinks a stock will go up, you protect yourself by buying shares now.

Buying options is a cheap way to get someone else to buy a stock, which pushes the price up. If the price is going up, options sellers will snap up more stock.

There's two prominent versions of the Gamestop story. The first is that r/wallstreetbets represents so many angry average joes that they can "move markets" by buying unlikely shares, like Gamestop or AMC, and confound the markets. (…)

The second story is that r/wallstreetbets has figured out a hack. They inflict asymmetric pain on shorts (a tiny gain for average joes is a huge wound to the sharks). By buying options, they can eke out tiny gains for a fraction of the price. (…)

But there's a THIRD story, and I think it's the most important one. That's @alexisgoldstein's account of what's going on with Robinhood and the institutional investors it's in bed with. (…)

Recall that all of this is only possible because Robinhood lets average joes buy and sell stocks for free. How can Robinhood give away a service that costs it money and still stay in business? (Hint: They're not making it up in volume). The answer is: surveillance. Robinhood partners with institutional investors and lets them spy on what the average joes are buying and selling. Sometimes, this is just "market intelligence" ("Hey, people like fidget spinners") but the main event is front-running. If you're paying Robinhood to tell you what assets its customers are about to buy, you can go out and buy them up first and sell them for a profit to Robinhood's customers.

Or you can buy some of that asset up because you know its price will go up once Robinhood's customers orders are filled. Or both.

Citadel Securities is Robinhood's main institutional investor partner. Founded by billionaire Ken Griffin, they combine tech (high-frequency trading), an "asset manager" (they spend other peoples' money) and a "market maker" (they sell things like options). Citadel gets to see all those r/wallstreetbets buy orders before they're filled. They can fill some of those orders, making a profit. They can buy some of the same stock for themselves, making a profit. They can sell options, making a profit. A little bit of this profit comes at the expense of average joes: if there wasn't a front-runner marking up the stocks they buy, the average joes would pay a little less. But the average joes are still profiting from the destruction of the shorts.

Citadel is merely taxing their winnings. The real losers here, though are Citadel's competitors, funds like Melvin Capital, who were seriously short on Gamestop and went bust thanks to all of this. Guess who bought Melvin at fire-sale prices? That's right, Citadel.

So the third story goes like this: there are a lot of average joes. They're numerous, pissed and smart. They move a lot of money against shorts and make it go farther thanks to the force-multiplier effect of options. THEN all this activity is multiplied again by Citadel, a fund that is no better (and no worse) than Melvin or the other targets of the average joes' wrath. Citadel's bots are triggered by the average joes' activity, which turns kilotons of damage into gigatons. It's not clear whether the average joes know they're triggering Citadel's bots, or whether this is just Citadel's bet on frontrunning average joes paying off for Citadel. It's possible Citadel is the joes' patsy, and the joes are ALSO Citadel's patsies.

It's also not clear whether Citadel - and its feuding cohort of competing finance-ghouls - can contain the storm. Maybe they profit off the average joes now, but the joes figure it out and turn their weapons on Citadel and the whole system later. Remember, the "legitimacy" of a financial strategy isn't determined by its objective decency, but rather by the power of the people who deploy it. If the average joes can attain respectability, they may be legitimized.

But the road to legitimacy is rocky. Yesterday, the finance monopolist TD-Ameritrade halted trading on the stocks targeted by the average joes. Today, Robinhood followed suit. Maybe they fear that they can't control the monster they created? eof/ (…)

Want a surveillance-free, ad-free blog version to link to and share? (…)

©2000 by Howie Klein. Leading The Progressive Fight Online Since 2000

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