This week, it has been impossible to avoid mentions of GameStop or Robinhood on social media, in the news, or even during a casual conversation with friends. The story behind the situation can be confusing to some, but, in reality, it’s as simple as many concepts we read about in economics or history textbooks. Many have deemed the current clash between “Wall Street” (inclusive of big hedge funds and CEOs) and “independent investors” (average people with stock portfolios) a “David and Goliath” battle, with David undoubtedly getting the best of Goliath. But what is really happening with GameStop or Robinhood, and why is everyone up in arms? Here is a simplified explanation.
The central concept of this issue revolves around an economic concept of a “short.” This term has been popularized in recent years by the movie The Big Short but is still little understood by many people. In essence, if we think of the stock market as a casino and “Wall Street” as a group of high-rolling gamblers, a short is basically when these gamblers bet against a certain outcome. In this case, large, powerful hedge funds (investment firms for high-net-worth individuals who don’t manage their own portfolios) noticed many deteriorating brick-and-mortar companies were on the brink of collapse at the start of the pandemic. These companies include AMC movie theaters, Bed Bath and Beyond, and, of course, GameStop. They believed the lack of customers due to COVID-19 limitations would bankrupt the firms and generate tremendous profits. Many of these hedge funds placed millions of dollars in shorts against these companies and then sat back to watch them fail. Once the short sales had been placed, the funds would make more money as the price of these various stocks continued to deteriorate.
From here, as Wall Street sat back and waited to profit, other forces began to come into play. Many factors can increase the trading price of a certain stock. In the case of GameStop, news and social media combined to make the perfect storm. First, GameStop announced it would add new members to its board of directors to reinvigorate growth. This ticked up the share price and even prompted some hedge funds to abandon their positions. Next, a Reddit channel known as “wallstreetbets” started encouraging the masses to buy up shares, and, thus, inflate the value. The stock had soared in the previous weeks, so many amateur investors took this advice and ran with it. Even Elon Musk shared the Reddit link to his Twitter, which further contributed to the frenzy. By the end of last week, the stock’s price had demonstrated 8,000% growth. Driven primarily by independent investors on the stock-trading platform of choice, Robinhood, Wall Street’s short sale quickly spiraled into a “short squeeze.” This means that the online chatter regarding GameStop and the hedge fund shorts caused everyday people to scoop up shares, leading to a grossly inflated valuation and even more extreme losses for hedge funds.
On January 28th, Robinhood temporarily disabled users’ ability to trade GameStop and other stocks in response to this “crisis.” The move was likely brought about by pressure from Wall Street or power players (namely the Mets owner, Steve Cohen). After all, S3 Partners, a financial data collector, estimated that losses by short-sellers just this month totaled more than $23.6 billion. No matter what caused the “temporary shut down,” the behavior by Robinhood to impede upon the free market is not legal. The fallout from these events remains to be seen, but understanding the GameStop short squeeze of the past few weeks is essential to understanding money, power, and influence in the age of social media.