The Stop Game Stop Game

The Stop Game Stop Game

I have been asked by several friends to write about the Game Stop issue and whether this is a new trend with the little guy triumphing over the big institutional investors on Wall Street. I know that everyone loves an underdog story, a David and Goliath battle where the stone and sling slay the giant. Everyone wants this to be a turning point where the rich stop getting richer and the poor get their moment in the sun. For Christ’s sake, at the center of this story is the new online free-wheeling small investor behemoth, Robinhood Financial, the platform used by so many small investors to make their plays on Game Stop and AMC that they were forced to halt trading for reasons of volatility and the concomitant ballooning capital requirement issues it faced. Robinhood, taking from the rich and giving to the poor. It is the oldest story in the world and will forever be the stuff of legends. But what’s really going on here?

My youngest son called me the day before Robinhood halted buying of Game Stop and AMC on their platform that serves 13 million small (and mostly young) investors. One of those investors is apparently my son. He is 25 and has never called me before to discuss an investment issue with regard to what he should be doing. It seems several of his friends are day-trading and he called to ask me to walk him through the issues and help him decide what he should and shouldn’t get involved with. I talked him through what I would call the basic primer on investing. To put that in perspective, I have an MBA in Finance, I spent 45 years on Wall Street, I ran three of the largest investment management firms in the world (ones that serviced institutions and individuals, and offered passive and active management products as well as a whole array of hedge funds), and I was a Clinical Professor of Finance at Cornell’s Business School teaching courses in asset management. He knew all of that, but what he may not have specifically known was that I taught a course in securities lending, perhaps the only specific course in securities lending offered in any business school. That course was about shorting securities and was called The Short Side of Alpha (Alpha being the measure of outperformance in the securities markets). The Game Stop story is the story of short-selling a stock and getting hammered for it.

I did not focus my attention with my son on the short selling issue because that is somewhat of an advanced course in investing and he needed Investing 101. After I explained what I described as the three ways he or anyone can choose to invest and the obligations that go along with those methods. I also told him a story. It is the story of Joseph Kennedy, father of JFK, RFK and Ted Kennedy. The legendary story of how Joe Kennedy made his wealth took place in 1929, while on Wall Street, when he stopped to get his shoes shined. For the next ten minutes he listened to the boot black boy tell him about all the stock investment plays he was making and how he could leverage his bets with margin, which was all a sure-fire way to get rich quick. Joe Kennedy took this message to heart immediately and saw it for what it proved to be, a stark signal that the market was overheated and the loose securities regulations of the day made it easy for small investors like the boot black boy to get way out over their skis in the market. Kennedy famously shorted the market on this sentiment and made the kernel of the Kennedy fortune from that short sale position.

In telling my son this story, on this night, the irony of the story was not lost on me. In that instance, the guy who was savvy enough to opportunistically short the market is the guy who made the killing. Of course, the real lesson in the story is not at all about shorting, but rather about the “gold rush” bubble mentality that often grips the market and especially small investors. And then how that buying signals the overcooked nature of the market and the inappropriateness of small investors piling into the markets with minimal understanding or fundamental research. Luckily for me, my son seemed to get that moral of the story very easily and appreciated the lesson imbedded therein. He did not get into the tertiary issue of how Joe Kennedy made his killing by shorting where the Hedge Funds shorting Game Stop were at the short end of the stick and the hordes of Robinhood investors shoved the Game Stop stick up their backsides by running the price of Game Stop (and AMC) up well above any rational and defensible valuation. In the current day case, that same irrational exuberance by the little guy won the day.

I’m sure that some of the more sophisticated individual investors taking that play did so understanding the nature of short selling and the inherent risk they were exploiting by creating an historic short squeeze against the offending hedge funds. But I am equally sure that many of those small investors had no clue what they were doing or why, they just joined the gang and ran the price up, the smarter ones making their profit and selling to the dumber late comers who jumped in after the cow was largely out of the barn and the shorts had mostly been covered. I doubt seriously that many of the Robinhood investors knew how to properly value a security and whether the price they were buying Game Stop at made any sense in the logical context of the company’s business. Therefore, while this play wrecked havoc with the shorting hedge funds and made lots of savvy small investors a bundle, it also left the latecomers with a shitty stock at outrageously high prices that had nowhere to go but down. When the dust settles, since the stock market is, by definition, a zero-sum game, the winners equaling the losers, we know that the huge loses inflicted on the hedge funds was pocketed by some, but those same winners also pocketed more gains that will eventually come out of the pockets of other not-so-savvy small investors.

People became enraged when Robinhood stopped trading in Game Stop and AMC the day after the big run-up. Actually, they didn’t stop all trading, just the buying of the securities. They allowed selling into the market. Think about it. Robinhood did not stop investors from cauterizing their loses, they only stopped them from increasing their loses. They were doing the dumb little guys, the ones who most need regulation to protect them, a favor. I’m sure the complaints came mostly from those small investors who wanted to scrape off their high-priced positions onto those same dumber small guys. The justifiable situation for Robinhood was that its governing capital regulations severely limited the amount of added Game Stop and AMC buying that it could reasonably support. Those capital requirements are in place for a reason, to further protect small investors that use their platform. But of course that was all lost on everyone and the smart guys were screaming the loudest since the little guys figured out (late though it was) that the game on Game Stop was over and it was best for them to get out and lick their wounds.

Short selling is one of the most perilous and arcane activities on Wall Street. If you look at the hedge fund categories, the worst performing category is almost always the short sellers. It is a tough place to make a living. When you win, you can win big, but when you lose, which is most often, you can loose a little very slowly (1,000 paper cuts) or very big (a quick stake through the heart), like happened here. So the next time you decide to try to stop the Game Stop game, think carefully about jumping in the pool with the short selling sharks. They won’t always fall prey to the guppies.