Who knew GameStop would itself become such a game?
Last summer, the video game retailer was seen as a fading brick-and-mortar operation. It was losing money, sales had been shrinking for years, and the stock was trading for around $4 a share. As I’m writing this on the afternoon of Wednesday, January 27, its stock is trading at $339 a share. At the close of trading on Tuesday, it was a mere $148. Not a bad overnight return, 129 percent. Three days earlier, it was at $38. It was up nearly tenfold in less than a week. Why?
To answer that requires explaining the concept of short selling, which most civilians find nearly incomprehensible. A short sale is a bet that a stock (or any other speculative asset, like bonds or gold) is going to decline in price. But to make that bet, you have to sell something you don’t already own, which is not normal behavior. To accomplish this, you have to borrow the stock from somebody who does own it. As with any loan, you have to pay interest on the borrowed asset. And you also have to keep some collateral on deposit with your broker as an assurance you’re good for the money. The hope is that the price will fall, and you can buy the shares — cover the short, in the jargon — at a lower price. Your profit would be the difference between the original sale price and the closing purchase price, minus any interest paid on the borrowed asset.
But what if you’re wrong, and the price rises? Then you’re in trouble. When you buy a stock, your risk is that you could lose the entire purchase price — but no more. With short selling, if you’re wrong, there’s no predetermined limit to how much you can lose if the price keeps rising. And if the price keeps rising, your broker will demand more collateral in the form of real money. You have a choice between giving up — covering the short and taking the loss — or keep pouring more collateral into a losing position in the hope that things will finally turn your way.
Back to GameStop. Last August, the investor Ryan Cohen, who founded the online pet food merchant Chewy and sold it for a handsome profit, started buying GameStop shares. He told the company that it needed to get with the digital age, close a lot of stores, and move online. Investors, expecting a better future for the flailing retailer, snapped up shares, tripling their price by the end of November. That was unjustified optimism, perhaps, but not outlandish. But some hedge funds, notably Melvin Capital Management, began shorting GameStop, believing the tales of recovery were delusional.
Cue the habitués of the subreddit Wall Street Bets, with a user known as DeepFuckingValue among the ringleaders, who began talking up the stock and buying shares. They were motivated not merely by the prospect of making money, but also for the lulz of bankrupting some hedgies. They began buying the stock in size, as they say on Wall Street. The ensuing price rise forced the shorts like Melvin to cover. Their demand for the stock, plus the Redditors’, launched the share price on a moon shot.
GameStop has turned into one of the great bubbles of our time. On Tuesday, January 26, more stock in GameStop was traded than in Apple, the biggest stock of all, with a total market value 108 times the retailer’s. As James Mackintosh of the Wall Street Journal put it, the price action and trading volume together suggest “widespread disturbance to people’s judgment.”
Bubbles like this always end in a crash, and those Redditors who haven’t sold their shares will be left holding a very depleted bag. (Surprisingly, news that Melvin closed out its short position late on Tuesday seems not to have dampened the party. A bubble usually goes on far longer than mere rationalists can predict.) In the meanwhile, it’s funny to see some Wall Streeters complain that there’s something unfair about this action, since these are the sorts of games they play with each other and the general public all the time. They talk up stocks or talk them down, depending on their interests, and plot against what they see as weak or vulnerable players all the time. It’s just that the speculators with names like DeepFuckingValue who are savaging them for now are the wrong kind of people. They don’t live in Greenwich in houses with twenty-car garages.
Even more amusing are the earnest sorts who think these games somehow pervert the function of the stock market. As Business Insider columnist Josh Barro declared on Twitter: “I know people think this is fun but — why do we have a stock market? So productive firms can raise capital to do useful things. Detaching stock price from fundamental value (Gamestop is now worth almost as much as Best Buy) makes the markets serve the real economy worse.”
What’s funny about these comments, aside from their earnestness in the midst of low comedy, is that the stock market has almost nothing to do with raising money for productive investment. Almost all the stock that trades on the market, including GameStock, was issued years ago, meaning that companies don’t see a dime of the daily action. Firms do issue stock now and then, in so-called initial public offerings (IPOs), but over the last twenty years, according to finance professor Jay Ritter’s data, IPOs have raised a cumulative total of $657 billion, well under 2 percent of total business investment in things like buildings and equipment over the same period. In the real world, as opposed to Barro’s imagination, firms raise almost all their investment funds internally, through profits. Rather than raising money from shareholders, businesses shovel out vast buckets of money to them. Since 2000, the five hundred large companies that make up the Standard & Poor’s 500 stock index have spent $8.3 trillion buying their own stock to boost its price — over half their profits over the period, and equal to almost 20 percent of business investment over the two decades. Stock buybacks not only make the shareholders happy, but they also fatten CEOs’ paychecks, since bosses these days are paid mainly in stock.
Lulz aside, this drama, like the seemingly endless rise in stock prices since 2009, interrupted briefly by the COVID-19 scare last March, is a sign of a financial system totally out of touch with economic reality. Trillions in government aid to business and Federal Reserve infusions into the financial markets have created a monstrous gusher of money with nowhere to go but speculative assets, at a time when ICUs are at capacity and 24 million people tell Census Bureau interviewers that they’re having trouble getting enough to eat. Barro would do better to worry about that.