Lessons from GameStop

I didn’t expect to write about this, but this story seems to have legs! I’m talking about the GameStop Saga.

The gist of the story is that an online community of stock market observers who were participating in social media forums had an unexpectedly large reach; and they appear to have orchestrated or initiated an effort to run up a stock’s price. The stock in question, GameStop, had traded in the low $30-range back in 2016, but it suffered a fairly steady decline, ending up in the $5 to $6 range by the end of 2019. In September of 2020 the price started to show some signs of life, closing the year just shy of $19. Since then, the price has skyrocketed, peaking at $483 but retreating to $325 by the close of January.

I’m unsure as to whether those who precipitated or joined in on this effort to goose the stock price were/are operating legally or not, but they’re certainly damaging to the general confidence in the workings of the market — and that’s not good. I’m afraid, however, that many may take the wrong lessons from this history. From some conversations I’ve had, it’s clear to me that many have been seduced into thinking that there’s easy money to be made in the stock market, but this story isn’t over, and the corollary that may be obscured is that it’s easy to lose in the market, as well. The right lesson is that different groups can (and will) manipulate individual stock prices; and which stocks are affected would seem to be somewhat random. The only real protection people have from that kind of shenanigans is owning broad portfolios.

The ringleader of this effort to boost GameStop’s share prices has been identified as investor Ryan Cohen, who, according to Wikipedia, had assembled a holding of 12.9% of the company’s outstanding shares as of 12/17/21. At some point, Cohen started to use social media to promote the stock, making part of the rationale the motivation to punish those who maintained short positions — most of whom where large hedge funds. It seems that Leon Musk got into the act, with additional comments on twitter that egged on this idea of punishing the shorts.

On some level, I appreciate the sentiment that big players may enjoy some advantage in the stock market, making them a target for criticism; but the derision that seems to apply especially to short sellers is … shortsighted. As is probably well understood by most readers, short sellers are those who sell shares without owning them. To affect this trade, those shares need to be borrowed before they can be sold. Subsequently, when short sellers decide to exit the trade (either having made or lost as much as their appetite permits), they cover the original sales by buying shares back. Those shares acquired with the purchases are then returned to whoever lent them in the first place. Thus, short sellers actually undertake two pairs of transactions: (1) borrowing and returning shares, and (2) selling and then buying back shares.

If we recognize that stock prices are often subject to “animal spirits,” where collective changes in sentiment can move stock prices to levels that may be unrelated to the underlying economics, we should be able to appreciate the constructive role of short sellers. Their involvement serves to put a check on the excesses that arise largely on the basis of momentum. In the GameStop case, where the price history unquestionably conforms to that of a classic bubble, short sellers weren’t the problem. Just the opposite. A bubble developed as a consequence of too few short sellers participating.

I don’t have much (any?) sympathy for those who’ve lost money (or will lose money) in individual stock speculations. The big concern is that if significant institutions place outsized bets that threaten their financial viability, their demise could have cascading effects. The danger is that we may have too many trading entities that are too big to fail, forcing the federal government to bail them out. This kind of bailout is one that I generally find abhorrent but sometimes necessary. The lesson from 2008 is that, if we do have to bail these firms out, we need to do it in a way that doesn’t end up rewarding company officers in the process.

I don’t know how precarious the current GameStop situation is. I hope not so much.