The GameStop short squeeze and why any market indigestion can be very bad for working people

Lisbeth Latham

Over the last week social media and the mainstream media has been filled with stories of how Redditors may have bankrupted some hedge funds who had been attempting to short the stock of US games retail company GameStop which had been struggling during 2020 under the dual pressures of the COVID pandemic and the increasing competition from games streaming platforms for market share. Much of the commentary has been a level of schadenfreude at hedge funds being beaten at their own game, which is understandable - however in enjoying the idea that this is ordinary people bringing down mighty capitalists, it is important to understand that the potential impact of the disruption of the shorting of GameStop is potentially much broader than that event, and the impacts will potentially be felt outside the stock market, and if that happens it will be working people who pay the price.

The origin of the stock market was a mechanism for raising capital for the establishment and expansion of companies. Companies, in exchange for investment, would offer other capitalists ownership of part of the company (i.e. shares) these could then be traded on the stock market with other capitalists. Originally the main value of shares was that they entitled their owners to a share of future profits - dividends. However as capitalism expanded and the opportunity to invest in profitable expansion of production in the real economy the stock market became an avenue for the investment of excess capital for speculation, but rather than for long-term returns on company profits speculation was based on short-term returns on variation in stock value and the creation of novel financial instruments that could be traded and invested in. For decades the stock market has primarily served as an avenue for such speculation by capitalists who are able to achieve better returns via such speculation than they can via investment in the “real economy”. This reality has been exacerbated in the last year where disruptions in the real economy caused by the COVID pandemic has further disrupted the real economy and there has been more concentrated speculation in stocks seen as either safe bets - such as big tech stocks - or raiding stocks which are seen as vulnerable, as was attempted with GameStop.

GameStop had been widely seen as one of a number of legacy stocks whose business had had its day. In late 2020, the value of the shares in a number of bricks and mortar companies such as GameStop, AMC Entertainment (US cinema company), and BB Liquidation (the holding company for the liquidation of BlockBuster). A number of hedge funds predicted this rise would be short term and began to short the stock - they were not quiet about their efforts and more and more funds joined the effort, demonstrating the irrationality of the marketer as the total short position of all the hedge funds accounted for 140% of GameStop stock.

Shorting is essentially a bet, or speculation, that a financial instrument will decline in value in either immediate or medium/long term. Depending on the type of instrument you want to short you will do it in different ways. With stocks, an investor will “borrow” stocks from another owner with an agreement to return them at a later date. The investor then sells the stock, reaping the full value at their current price on the assumption that when they need to return the stocks they will be able to purchase the stock at a lower price than they sold it at - they reap the profit between the two values - if the stock instead goes higher then they will lose money on their bet.

In response members of the sub-Reddit WallStreetBets, which regularly coordinates collective short-term investment by small traders, noticed the massive short and proposed an effort to boost the share prices of these three shares using online trading platforms such as RobinHood - as doing so would not just undermine the shorts of the hedge funds but provide an opportunity to also make money as the hedge funds tried to cover their losses.

Between the close of the exchange on Wednesday, January 20 and January 27, the price of Gamestop stock had risen from US$39.12 to US$347.51. A number of the hedge funds had already covered their position by the close of trading on the January - hedge fund Melvin Capital announced they had covered their short position for a loss of US$2.75 billion while Citron Research reported it had covered the majority of their short with a 100% loss of their investment. The need for hedge funds to cover their short position and buy massive volumes of shared was a major factor in the driving up on the share prices, adding to this was other investors seeing an opportunity to make money in the process and buying shares in the hope of selling them again to the hedge funds.

The response by many to the events around GameStop has been one of joy at the pain being experienced by hedge funds. While this demonstrates understandable hostility to Wall Street and more particularly hedge funds, which are thoroughly parasitic, however, the process has a much wider impact than simply these funds losing money or potentially going bankrupt - this has the potential to spread much further through stock markets and more problematically into the real economy.

It is estimated that hedge funds have lost up to US$5 billion in their short, most companies do not have that level of liquidity, as a result in order to cover these losses they have had to sell other assets to meet their obligations - in a number of situations the shares they have gone long. Offloading large volumes of collateral at short notice can only result in driving down the value of those assets and potentially forcing others, particularly those who are heavily leveraged, to dump their position to avoid the risk of losing money themselves. For this reason, there has been a dramatic increase in the level of volatility in stock markets with the Volatility Index rising sharply. A number of tech stocks that had been massively overpriced over the past year have seen massive sell-offs. A primary driver for this has been the need of hedge funds covering their short positions selling their long positions in these stocks - but also other investors selling in response to the volatility with stocks such as Netflix dropping five per cent.

The problem with this process is not that an individual hedge fund may collapse, or that this or that firm may see it’s stock rise or fall, or that a lot of the people participating in the events of Wednesday will lose a lot of money - while others will make a fortune. Let’s be clear everyone involved was participating in a gamble to make money, no matter what their professed motivations. What we should be concerned about is that the stock market - whilst technically separated from the real economy can cause major disruptions to the real economy. An economy which is extremely fragile due to the impact of not the Pandemic but the lingering effects of the 2007-2008 global financial crisis and the ongoing accumulation crisis which was highlighted by the 1973 oil crisis. What this means is that sneezes such as that of January 27 risk a broader financial collapse, the consequence of which will not be primarily felt by billionaires but by ordinary working people who will lose jobs and see their retirement funds evaporate - just as has happened after every major stock market crash.

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