It feels wrong to hope that a company goes bankrupt and its stock craters are at zero, which is why short sellers – the traders who make money from the stock tank – are treated with disdain in many corners of Wall Street and now increasingly in Washington.
But the devil deserves some sympathy in this case. Without short sellers, the investing public is really doomed. And as proof, look no further than a one-time penny stock that goes back to nosebleeds.
The stock, of course, is GameStop, a video game retailer undergoing corporate restructuring that includes store closings and, according to many analysts, an outdated business model as people increasingly buy video games online rather than in stores.
As we all know now, GameStop has become a market fan of beginner traders for reasons that defy logic – sending the stock to a high of nearly $ 500 a share a few weeks ago before crashing and then recovering this week.
Initially, the stock was bolstered by an unusual array of factors, including chatter on Reddit message boards that the company was on the road to greatness. Fuel was topped up by budding traders armed with a free trading app from Robinhood and a deep desire to stick it to the big boys betting on the stock’s fall.
Short sellers will borrow shares of stock, sell them and pay back the loan at a later date, bet shares will fall. That is why they make a lot of money from the stock. But they can lose a lot of money if stocks they fall short rise, which is what happened with GameStop.
The mania caused a brief shortage and hedge funds were crushed. Robinhood had to stop trading because it did not have the capital to settle and process all transactions.
Eventually, the House Financial Services Committee held a hearing to sort things out. But the committee mainly tried to blame hedge funds that were short on stocks.
What was largely overlooked in the hearings was that even when the hedge funds lost money, they were ultimately proved right. As they predicted, GameStop’s stock collapsed. Small investors who ignored the short statement and engaged in the Reddit-induced mania of buying near the top (sometimes with borrowed money) were crushed when shares plummeted below $ 50.
Last week, GameStop’s stock climbed again, reaching nearly $ 200 a share, before settling at just $ 100, which is still light years above last summer’s penny stock level of less than $ 4. And that’s setting up small investors to get in trouble again.
I took a stroll through the mud on Reddit’s “r / wallstreetbets” thread, the epicenter of the GameStop tout, to see what, if anything, is being pushed about GameStop’s business model. The answer: very little, although I did find a message from a user who promised to “tattoo the wallstreetbets logo on my right buttock if we take GME to $ 1,000”.
Notice the language here, “If we get GME at $ 1,000.” It is typical of stock buying where traders hype stock for insignificant reasons. The stupid money storms in and pushes stocks further up before savvy traders dump their holdings for profit.
Of course, it’s impossible to know if GameStop will match $ 1,000 a share or even the $ 500 it nearly reached during the peak of the mania in late January. But this time around, there are reasons to believe that the losses for average investors could be even greater: there is a lack of short sellers providing a much-needed second opinion.
Short-term interest rates in GameStop, which had surpassed 100 percent of the float in January, have fallen dramatically.
Hammered by the short-squeeze and Congress (during the Finance Committee hearings, committee chair Maxine Waters used the term “ predatory ” to describe short selling), the shorts are now taking cover. The information flow is dominated by the touts.
As I’ve reported on Fox Business, legendary short-seller James Chanos is concerned about the market implications of the anti-short mania that is engulfing retail investors and now possibly Congress.
Chanos, a friend of President Biden, has reached out to White House economic aides to convince them that short sellers are needed now more than ever. Record low interest rates, free trading apps and message board hype set a perfect storm of retail investors pulling in speculative stocks that are likely to implode when reality strikes again.
Chanos, of course, is one of those evil short sellers who have made a fortune with the stock crashing, so consider the source. Recently, he made what many touts consider a mistake by stating that Tesla was a “walking insolvency”, given where the stock is traded and how the electric car manufacturer fares today.
Time will tell if he’s wrong.
But about 20 years ago, he made history with research that uncovered one of the biggest corporate fraudsters ever – the Enron accounting scandal. Investors who listened to him made money; those who did not lose money. Regulators who ignored him were forced to reform accounting laws for greater transparency.
Count me as someone who thinks we need to hear more from people like Chanos as markets hit new highs, while low interest rates and free trading apps prompt more first-time investors to think trading is a situation that can’t be lost because that’s what they ‘reading on Reddit.