Unless you live completely off the grid, you have most likely heard something about the GameStop boom last week. For those unaware, a hedge fund, Melvin Capital, held very large short positions against GameStop, a brick-and-mortar gaming store whose stock has been falling steadily over the past decade due to the rise of e-commerce. An otherwise reasonable bet made a turn for the worst for Melvin as online investors, fueled largely by a sub-Reddit, led to a buying frenzy, leading GameStop’s stock to rise from $76.79/share on Monday, January, to $347/share on the 27.
As a result, in the course of two days, Melvin faced bankruptcy and needed a larger hedge fund, Citadel, to bail it out. A major trading platform, Robinhood, restricted purchasing GameStop shares, in addition to a few others fueled by activity on Reddit, allowing traders only to sell their stocks — an effort that has led many to conclude that they were trying to push down the stock value. The stock did fall that day from $347 to $193/share; it is currently at $135.
Is Wall Street a Wave or a Particle?
Such an action, however, is potentially illegal, as the stock exchange can only legally restrict the trading of particular stocks under very specific situations of fraud and material evidence. Of course, many people on the Robinhood platform have since filed a class-action lawsuit, and the results are forthcoming. Even more interesting is that Citadel also serves as Robinhood’s main shareholder. Regardless of whether or not what happened on Reddit is (il)legal and should be regulated, we witnessed an extreme event that has profound implications for the financial industry.
Of Swans and Turkeys
Many people are already referring to the GameStop situation as a black swan event. But can we really be surprised that people on social media were able to unite online in a manner that allowed them to manipulate the market, no matter how unexpected or monumental the move was? Shouldn’t Melvin have considered certain classes of events that would threaten its positions and created a means of protecting itself should such a rare event occur? It had to have known the potential risks to its investments but didn’t care enough to secure it in a classic turkey problem.
Regardless of whether or not this event qualifies as a black swan, Melvin clearly had an extremely fragile investment strategy unprepared to handle random, unexpected turns, as last week’s events clearly demonstrated. Many who have taken the side of Melvin and Citadel have been calling for regulation to prevent amateur investors from acting in such a manner, even though many of them are the very same people who have been fighting the regulation of the financial sector since the 1970s — and largely succeeding.
So what exactly does this entire episode teach us? Although the situation is still unfolding, we’ve already observed a decades-old pattern: The very people who manufacture fragility into the systems they oversee will be bailed out, forgiven and permitted to continue what they were doing all along. The people at Melvin were willing to make risky bets but did not want to have to face the consequences of their plan going awry — they did not want their skin in the game.
Instead, Melvin’s savior intervened and seemingly had Robinhood halt trading to drive down the stock price and save their short bets. Is that really how a free market works? Wouldn’t it be best in a free market environment to let those people who gambled so recklessly on certain positions that they bankrupted their entire company to go out of business?
These people are what Nassim Taleb would call “fragilistas” — those who manufacture fragility and never have to face the consequences if their decisions end up being disastrous, instead transferring the negative externalities onto the victims. We have witnessed this with the war on terror in general and in Iraq more specifically, with the 2007-08 financial crisis, and now the economic and public health crises emanating from the COVID-19 pandemic, not to mention the looming threat of climate catastrophe. The Melvin/GameStop situation is just the latest iteration.
Taking on the Fragilistas
None of these monumental mistakes would have happened on the scale they did if the perpetrators had skin in the game. In the case of Melvin, its skin was in the game without the hedge fund even realizing it — or if it did, without seeming to care.
Average investors now have a rather fascinating means of holding Wall Street accountable and redistributing wealth, albeit very modestly. They can and should find companies that have recklessly large short positions and unite to drive up those stocks in an effort to bring the money from the haves to the have nots like a real Robin Hood.
Big business, protected by every US administration since the 1970s, has been able to effectuate an enormous transfer of wealth from the American middle class and the poor to wealthy Americans and poor laborers abroad. The workers never had a say in matters of losing their jobs to automation and outsourcing. Average people also had no recourse during the financial crisis of 2007-08, and they have no recourse now with the multifaceted COVID-19 crisis all while they watch billionaires multiply their net worth.
It’s high time those who have been abandoned by society find a way to fight back and put powerful people’s skin in the game. We shouldn’t see the GameStop situation as just a fluke. It should be the first manifestation of a form of financial activism. Let’s get out there and short squeeze a few more fragilistas.
The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.
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