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Who Is Allowed in the Smoke-Filled Rooms of Investment?

How the stock market is manipulated, using the GameStop episode as an example

Full disclosure: I continue to maintain positions in some of the stocks mentioned in this article. But, as you will see, my goal here is neither to promote stock or dissuade from it, but rather to ask a deeper question about who is allowed to do what about a stock.

For those who are unaware, the last two weeks in the stock market have gone crazy. GameStop (GME), a company that continues to lose money, skyrocketed from $18/share to, as of the time I’m writing, just about $450 per share. That’s right the stock soared over 20 times in value over the period of a few weeks. Several other stocks have also skyrocketed, including AMC Entertainment (AMC) and Koss Corporation (KOSS). Koss, for instance, went from $3/share to over $140/share.

So what triggered this inflation of value? A group of investors on a public forum at Reddit, known as WallStreetBets, figured out that several companies were being overly-shorted.

What does that mean? If you buy a stock the normal way, you are “long,” usually with the strategy of buying low and selling high. However, more sophisticated investors, if they see a stock that they think is overpriced, can go “short.” This basically allows you to sell first, then buy later. So, if a stock is going down, you can sell high and buy low. You do this by borrowing the stock, selling it, and promising to buy it back in the future. If the stock price goes up, you have to buy it back at the higher price. You might be able to wait it out, but if you are wrong for too long or by too much, your stock broker is going to force you to buy the stock and return it.

With GameStop, there were actually more shares being shorted than were regularly traded. Therefore, WallStreetBets publicly engineered a “short squeeze”. Basically, they bought and bought the stock, raising the price. Eventually the short sellers were forced by their brokers to buy the stock back. Well, this means more buying. That propelled the stock price up even further. As the price continued to go higher, more stock brokers had to force short-sellers to buy back stock at ever-increasing prices. The folks at WallStreetBets just decided to hold on to their stock, and not sell, which meant that there were very few sellers and scads of buyers, which meant the stock propelled upward.

The losses from short sellers were in the billions. At least one hedge fund is apparently being bailed out.

Because of these incidents, Reddit closed the WallStreetBets forum. Stock trading app RobinHood suspended trading of GameStop. Discord shut down the WallStreetBets chatroom. If this sounds weirdly reminiscent of the Parler story. The public started doing things that the elites didn’t like, so the elites shut down the entire communication and operational pipeline of the dissidents.

Now, to be clear, I don’t have any love for GameStop or WallStreetBets. I think short sellers provide an important set of checks and balances to the market. However, I do think it is odd that the knives don’t come out when Jim Cramer pumps a garbage company’s stock, or when Carl Icahn engineers a short squeeze of Herbalife (HLF) to damage Bill Ackman’s hedge fund. Or take Tesla, which faked a corporate buyout on Twitter and profited from a short squeeze on Tesla stock, mailing a package of shorts to shortseller David Einhorn to rub it in. This is currently considered normal on Wall Street. But when ordinary investors do it? That’s when someone feels they have to put a stop to it.

The fact is, the insiders have been manipulating the stock market for years in various ways. If nothing else, when a hedge fund blows up, there are often bailouts at the end. If a hedge fund is bleeding money, the exchange may halt trading to help it out. In the 2010 Flash Crash, the NYSE cancelled the trades of algorithms that had gone too far astray.

If you or I make a bad trade, we have to eat the losses. Nobody bails us out. But if your losses are in the billions, you have cronies to help you out. The federal reserve may organize banks to give you a bailout, as what happened to Long-Term Capital Management. Or a combined bailout and buyout, as with AiG.

It may be that these actions were necessary at the time. The point is that retail investors have no backstop, period. They have to own their mistakes outright, no matter what. But, as we can see, the powers that be are manipulating the game for their benefit from both sides. A bailout for Melvin Capital was organized behind-the-scenes, and the ability of retail investors to trade as they see fit, or even speak in public, was removed.

I don’t think that engineering a short squeeze is what retail investing should be about. But I do think that doing it in public, by the public, in full view of day, is much to be preferred to doing it as a backroom insider deal. One user from WallStreetBets put it this way: “We don’t have billionaires to bail us out when we mess up our portfolio risk and a position goes against us. We can’t go on TV and make attempts to manipulate millions to take our side of the trade. If we mess up as bad as they did, we’re wiped out.”

We’re still in the first month of 2021, and we already have two large-scale incidents of Big Tech power against the public. If the public wants to reassert its will, we must either learn how to reign in these companies, go around them, or leave them in the dust.

There will always be elite and powerful people. If those people want to keep their positions of power, however, they have to learn to use that power for the benefit of the public, not just their friends.


You may also wish to read: Many are questioning the sudden shutdown of Parler. Opponents see the move as an attempt to enforce a social media monopoly.


Jonathan Bartlett

Senior Fellow, Walter Bradley Center for Natural & Artificial Intelligence
Jonathan Bartlett is a senior software R&D engineer at Specialized Bicycle Components, where he focuses on solving problems that span multiple software teams. Previously he was a senior developer at ITX, where he developed applications for companies across the US. He also offers his time as the Director of The Blyth Institute, focusing on the interplay between mathematics, philosophy, engineering, and science. Jonathan is the author of several textbooks and edited volumes which have been used by universities as diverse as Princeton and DeVry.

Who Is Allowed in the Smoke-Filled Rooms of Investment?