This article first appeared in The Edge Malaysia Weekly on February 1, 2021 - February 7, 2021

THERE was a time when a billion dollars was a lot of money on Wall Street. A big hedge fund would bet a billion and small-time investors would step back because they knew they couldn’t fight it. These days, with Reddit, Twitter, Facebook and other social media, it is possible to organise three million traders with US$1,000 to spare each. The collective power of connected retail investors is far bigger than billion-dollar hedge funds. Rookie investors making big, audacious bets and willing to organise themselves on social media are taking on well-known hedge funds and winning.

Last week, Melvin Capital, a hedge fund with US$12.5 billion (RM50.6 billion) under management, collapsed because it had built a huge short position on video game retailer GameStop Corp. Melvin was bailed out by two large hedge funds, Citadel LLC and Point72 Asset Management, which agreed to inject US$2.75 billion and close its short positions against GameStop. Short-sellers betting against GameStop have lost over US$5 billion mark-to-market so far.

GameStop stock, which was hovering around US$4 a share a year ago, became one of the heavily shorted stocks on Wall Street in 2020 as hedge funds bet that the bricks-and-mortar retailer with stores inside malls would soon go broke. Last year, a bunch of young traders noticed that short positions were almost 100% of GameStop’s available shares, or free float, and began placing contrarian bets that it would be revived.  Then, pet supplier Chewy’s co-founder, Ryan Cohen, emerged as a white knight. The stock surged and suddenly, there was a short squeeze as hedge funds rushed to cover their short positions by buying more shares.

Short selling involves borrowing a stock and immediately selling it. If the stock falls, investors make money by buying it back at a lower price. A squeeze follows a big gain in a stock when short-sellers are forced to cover their positions. In October 2008, Volkswagen briefly became the largest company in the world before falling 93%. The German automaker’s stock is still 80% below its all-time highs. Short-sellers, who bet against Volkswagen three weeks after Lehman Brothers’ collapse triggered the financial crisis, found out that Porsche, a key shareholder in VW, was accumulating shares. They got squeezed as the price climbed. Eventually, Porsche took over VW.

To be sure, the frenzy over GameStop has been months in the making. Over the past year, the world has seen a growing number of first-time individual investors, most of them young, enter the stock market. People forced to work from home and stay at home after work had more time on their hands and extra cash as they were no longer spending money at bars, restaurants or other recreation outside their homes or office commutes. In many countries, including in the US, governments sent citizens additional money as part of a broader fiscal package to cope with the pandemic lockdown, which only added to their cash pile.

Not surprisingly, newbie investors flooded internet chat rooms and social media forums to share trading or stock ideas with their peers. The advent of commission-free stock trading and fractional shares at online brokerages such as Robinhood that use confetti showers to celebrate transactions helped gamify and democratise investing. Individual investors across the US opened more than 10 million new brokerage accounts last year. Instead of forking out US$343,500 for a single share of billionaire Warren Buffett’s Berkshire Hathaway and paying a minimum US$10 brokerage commission, you can pay just US$2 and no trading fee for a small slice of the Oracle of Omaha’s iconic firm.

Reddit, a social news aggregation and discussion website co-founded by Alex Ohanian, husband of tennis star Serena Williams, has a popular forum, or subreddit, called WallStreetBets where newbie investors as well as some of the more savvy ones gather to crack jokes and comment on headlines, sports, entertainment and, of course, the direction of markets and indeed, individual stocks. Every stock tip is turned into a meme or an emoji. YOLO, or You Only Live Once, is a common reference to a risky investing bet on the forum. It is so popular that it now has nearly three million users. Reddit isn’t the only such forum; others like Discord have helped add fuel to the fire.

In recent weeks, a lot of chatter has been about old companies that in their heyday were patronised by their baby boomer parents — like cellphone maker Nokia Corp, smartphone ­pioneer BlackBerry Ltd, cinema chain operator AMC Entertainment Holdings and, of course, GameStop, which has struggled over the move to e-commerce as people download games rather than buy cartridges or DVDs from retail stores. Though the launch of new consoles such as Sony Corp’s PlayStation 5 and Microsoft Corp’s Xbox Series X in early December increased foot traffic to GameStop, the chain’s revenues have been steadily declining. For three years now, analysts and hedge funds have likened GameStop to Blockbuster, the video rental chain that went bust a few years ago as streaming giant Netflix Inc gained traction and other streaming services followed in its footsteps. Short interest in GameStop started to increase throughout much of last year as the US was in lockdown.

Markets may have been a little frothy lately but the GameStop phenomenon is nothing like a classic bubble, which almost always is driven by greed. Indeed, as Bloomberg columnist John Authers noted in a recent podcast, GameStop mania has been fuelled by anger. Young investors believe that establishment-run Wall Street is unfair. As such, their attack on shorts-sellers that led to the short squeeze on GameStop and catapulted its shares to record highs is really about earning back the money that Americans paid to bail out troubled banks such as AIG through the Troubled Asset Relief Program, or TARP, in the aftermath of the global financial crisis. If you read some of the posts on Reddit, you will find comments like “all of the gains from GameStop and (other) short squeezes are going to people who have never been rich or powerful and losses are all accrued by hedge funds or their wealthy investor clients”. The angry young investors see it as righting a historical wrong.

Think of these investors literally like latter-day Robin Hoods robbing the rich hedge funds to pay back the poor. After the 2008 financial crisis, angry young Americans gathered near Zuccotti Park in New York, not far from the New York Stock Exchange, to protest that no banker, hedge fund manager or derivative trader who profited from the subprime boom was jailed or even put on trial. Those protests dubbed “Occupy Wall Street” fizzled out within weeks.

On Jan 6 this year, social media helped hundreds of angry right-wing supporters of then president Donald Trump attempt a coup of sorts to stop Joe Biden from taking the helm of the world’s largest economy. Now, social media is helping Robinhood traders take on short-sellers amid a changing-of-guard of sorts on Wall Street. Among the people who tweeted in sympathy with Redditors was Tesla CEO Elon Musk. Sri ­Lanka-born billionaire investor Chamath Palihapitiya also bet against the short-sellers, as did Dr Michael Burry, an early GameStoop investor,  whose mortgage trade was featured in the book and movie, The Big Short.

On one level, the battle is between the little guy or the retail trader who is just trying to keep Wall Street honest, and billionaire hedge fund managers, the financial world’s equivalent of the establishment or people like the fictional cigar-chomping, take-no-prisoners trader Gordon Gecko in Oliver Stone’s 1987 movie, Wall Street.

On another level, it is akin to outsiders trying to shake up an entrenched establishment the way Trump took on  Washington four years ago. Indeed, an aide to former Senate majority leader Mitch McConnell tweeted, “Wall Street, welcome to our world.”

So, what’s next? As Buffett is fond of saying, you almost never find just one cockroach. There are probably a lot of hedge funds in distress that are facing a short squeeze and margin calls, some of which will have to fold or be rescued by bigger funds the way Melvin was last week. Others would have to deleverage, selling some of their good stocks to meet margin calls and pay creditor prime banks.

Will it spread over to other parts of the market and lead to a collapse? For now, it looks unlikely. But if it drags on and engulfs other hedge funds, things could turn messy. It could be a destabilising force in what is already a fully valued market. Clearly, the GameStop phenomenon is unsustainable.

Some in Wall Street are concerned that the GameStop mania could morph into a larger socioeconomic populist movement that is hard to control. Others believe there is likely to be even more political outrage if regulators just let the the frenzy continue, leading to a spectacular market collapse. Congressional hearings on the market turmoil in the wake of the GameStop squeeze are expected to begin soon and regulators have reportedly begun investigations.

It is likely that one day soon, Redditors will wake up and realise that their GameStop shares are worth a fraction of what they were at the peak. But it won’t end with just a bunch of young traders nursing their bruises. Behind the phenomenon was an algorithm that will be used to discover the next big GameStop or AMC, not tomorrow or next week but months from now. That will bring the next bunch of young traders eager to battle the hedge funds.  

Every year, in early May, Wall Street elites — hedge fund managers, brokers, investment bankers — put on their best suits for a charity lunch at New York’s prestigious Lincoln Center for the Performing Arts. The Ira Sohn Conference gathers America’s best short-sellers, who unveil their top “short ideas” in fancy 200-slide presentations. It is unlikely that short-selling will ever be the same again on Wall Street. Sure, there will always be investors taking a contrarian short position on a stock but the hedge fund industry, which just had its worst decade ever, will be more wary of making big bets as crowdsourcing ideas thrive.

The game has changed. Wall Street now has to reckon with a decentralised network of individual investors using technology to level the playing field for themselves and take on big institutional investors. Moreover, social media has helped change the investing world with increasing transparency. Melvin was driven to the wall because a bunch of rookie traders found out through Google Search that it had huge short positions, so they cornered it and eventually destroyed it.

The young Reddit members who trade on Robinhood have been galvanised by a Wall Street establishment that sees them as dumb investors, who don’t understand how financial markets really work and whose trades will eventually blow up. For their part, the young traders see themselves as underdogs in overdrive who are enjoying their newfound influence on Wall Street.

Wall Street is ready to fight back. It is playing victim, claiming that Robinhood traders have made a coordinated effort to corner the market, which is illegal. It is unclear whether the Securities and Exchange Commission (SEC), the main regulator, will side with the hedge funds.  The SEC’s primary goal is protecting retail investors.

“Redditors are doing exactly what billion-dollar hedge funds do every day — colluding to move a stock for fun and profit — the notion that this should be the subject of a federal investigation is preposterous,” columnist Matt Taibbi wrote on his Substack newsletter. America, as a society, will in the end unite to denounce GameStop as some form of “financial Trumpism”, he notes. Redditors believe “the stock market, like the ballot box, remains one of the only places where sheer numbers still matter more than capital or connections,” he adds. How they use their numbers, and any money they make battling the hedge funds, to effect change remains to be seen.

Assif Shameen is a technology and business writer based in North America

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