Reddit vs. Wall Street: Regulating is the Best Way Forward

Cover by TNGO illustrator Andrea Ruffoni Semidey.

In January 2021, bound-to-fail company GameStop saw the value of its shares soar 1,700%, marking the beginning of the Reddit vs. Wall Street confrontation. Behind the unexpected rise in share value were Reddit users from the subreddit r/wallstreetbets. The purpose of their “spontaneous movement” was to show discontent with the perceived unfairness of the financial market.

Despite popular support for the initiative, small investors encountered heavy financial constraints including the decision of online trading platform Robinhood to halt the purchase of GameStop shares. Overall, the impression was that “all animals are equal, but some are more equal than others“, meaning that amateur investors could not benefit from the loose regulations that apply to institutional investors.

The financial market, though, is a human creation and none of its features are “natural” or necessary. The system can be corrected and improved and this “David vs. Goliath”-like clash helped point out elements that need to be reformed or regulated. The first part of this article will sum up the events while the second part will point out the most problematic issues that have arisen. The third part will suggest some corrections that could improve the health of the financial market.

Reddit vs. Wall Street: What Happened?

Reddit vs Wall Street
The Reddit vs. Wall Street quarrel unfolded to the sound of memes. Source: The Tab

GameStop, the world’s largest videogame retailer, has been in deep water for quite some time. Especially during the pandemic as digital marketplaces got a foothold, the company liquidated 27.3% of its stores. By January 2021, GameStop shares were only worth four dollars each, and management predicted having to close 1,000 stores by April 2021. The backlash of GameStop workers to this news would have been devastating.

Things changed the moment some amateur investors from the subreddit r/wallstreetbets realized that GameStop was being “shorted”. Shorting a stock, essentially, entails betting against the rise (or the reprise) of a company. The proceeding is quite intuitive, albeit risky. In extreme synthesis, investors (usually hedge funds) borrow shares from a broker and sell them to a third party. The underlying condition is that the shares will be returned at a later time.

When, as expected, the company shares lose value, the investor buys them back at a lower price. This process allows professional investors to pocket billions, to the detriment of struggling or failing companies. This time, though, Redditors decided that they had had enough with this exploitative practice and took action to defy the financial system with a counter-campaign. Despite the lack of any centralized organization, they spontaneously started buying GameStop stocks by the thousands.

The “Short Squeeze”

A graphic representation of price change through a “short squeeze”. Source: IG

What started as a sporadic event quickly became a tidal wave. In the span of a few weeks, r/wallstreetbets grew from one to nine million subscribers. Contextually, the value of a single GameStop share rose from four to 150 dollars in late January.

This improvised “movement” gained the sympathy of Elon Musk. On January 26, 2021, Tesla founder tweeted a cryptic “gamestonk!” to show his support. Interestingly, US Congresswoman Alexandria Ocasio-Cortez also got on board with the sympathizers. This unlikely alliance proved that the Reddit “DIY uprise” was capable of gathering a broad and eminent fanbase.

What was the purpose of this coordinated action? The main idea behind the mass purchase of GameStop stock was to trigger a “short squeeze” to artificially increase the demand for a specific stock so that its price skyrockets. This, of course, upsets short sellers’ apple carts because these sellers had hoped that GameStop’s share value would drop.

Consequently, short-sellers had to buy back the shares they had previously sold, which is the only way to minimize losses during a short squeeze. By that point, however, the shares’ value was so high that losing billions of dollars was inevitable. From this perspective, the short squeeze was a way to “punish” Wall Street investors and their greed and “holding” the shares was the small investors’ way to make the process as long-lasting and hurtful as possible.

How’s the Reddit vs. Wall Street Confrontation Going?

Reddit vs Wall Street
Melvin Capital’s owner Gabe Plotkin became the face of the “evil” Wall Street. Source: Financial Times

Given that some investors are particularly combative, arm wrestling between them may go on for quite some time. Some of the effects are already apparent. The biggest short-seller involved, Melvin Capital hedge fund, lost 53% of its value. In absolute terms, that’s about 6.6 billion dollars. Not even a 2.75 billion dollar capital injection by Point72 Asset Administration and Citadel could contain the loss. In the end, Melvin Capital had to close its short position.

The main fear on Wall Street is that the hemorrhage could spill over to other hedge funds that also have short positions. For now, Citron Capital – another short-seller – has had to close its short position. According to its owner Andrew Left, it did so “at a loss, 100 percent” while at the same time, this momentary loss will likely not bring hedge funds to their knees, even if it does hurt them. However, a few billion dollars in losses are nothing unprecedented.

On the other hand, small investors are not winning, either. In fact, the value of GME has sharply decreased from its all-time-high in late January. As of mid-February, the value per share is $52.40. Why were Redditors unable to fully succeed in their endeavor? To answer this question, it is necessary to take a look at the problems that emerged as the events unfolded.

Reddit vs. Wall Street and the Problems of the Stock Market

The ‘Robinhood Dilemma

Reddit vs Wall Street
An ironic representation of Robinhood, hurt by its own arrows. Source: Ars Technica

The first problematic event occurred on January 28, 2021, when Robinhood – an online trading platform – prevented stakeholders from buying GameStop Stocks arguing that it was protecting customers against “market volatility”. This didn’t exempt the company from harsh accusations and users lamented that Robinhood was “doing the bidding of Wall Street and rigging the market against its own customers“.

The most obvious explanation is that “all animals are equal, but some are more equal than others”. In other words, professional investors can do almost anything they want and laws and regulations bend at their will. On the other hand, small investors can be prevented from exercising their right to profit from the stock market.

A more rational explanation is that Robinhood was simply serving its own interest. Most of its users are amateur investors, but they – unlike institutional investors – do not pay transaction fees. As a result, they have less bargaining power and their preferences can be put aside. In the end, Robinhood may have damaged its image beyond repair. Redditors are not forgiving and have already sued Robinhood for market manipulation.

The Stock Market Reaction: Blaming David for Goliath’s Faults

On Wall Street, the stunt pulled by Redditors triggered unprecedented disarray. Traditionally, professional investors are the self-styled champions of neoliberalism who claim that the State’s role in the economy should be minimal in the name of “freedom”. As it became increasingly undeniable that hedge funds were losing billions, the narrative began to change.

That’s when Wall Street investors started asking for heavy-handed State regulations. In short, not only did hedge funds indulged in years of predatory behavior, “hammering fragile companies into extinction“, now, the Security and Exchange Commission (SEC) also needed to withstand their outcry.

Interestingly, Wall Street investors began criticizing, the flaws of Redditors that are usually attributed to them to the point of calling those involved “the financial equivalent of the White House insurrectionists“. While their behavior was destabilizing, isn’t that the objective of every protest? At the very least, this event clarified that Wall Street investors do not want the loose regulations that apply to them to be extended to everyone in the stock market.

The Core Issue: Social Injustice

Garth Theunissen of the Financial Mail offered a more interesting read of Redditors’ actions. He wrote that “the GameStop phenomenon isn’t just speculation. It’s anger.” But where did this acrimony come from? The motivations of small investors are varied and personal, but it appears that this anger dates back to the financial crisis.

Many Redditors shared their stories, entailing job losses, debts, and shattered families. One user even posted an open letter to Melvin Capital, the hedge fund that bet against GameStop. Among the accusations are exploiting struggling companies and manipulating the market, making it hard to deny that social injustice is at the core of what happened. The widespread perception is that, back in 2008, banks and hedge funds were unfairly bailed out while average citizens, on the other hand, were left to struggle.

While the grudges against Wall Street are ancient, the pandemic may have played a role in triggering the r/wallstreetbets movement. In fact, after a momentary shock at the dawn of the pandemic, the stock market has thrived during the crisis. Billionaires made huge returns, while everyday people were losing jobs and getting sick which, in turn, unleashed the social discontent buried after “Occupy Wall Street” once again.

Reddit vs. Wall Street: The Battle that Could not be Won (but Needed to be Fought)

A picture from Occupy Wall Street, the “precursor” of Reddit vs Wall Street. Source: The Week

While Redditors failed to topple Wall Street’s regime, it is likely that this was through no fault of their own. On the contrary, there are elements suggesting that the financial game is “rigged” by allowing the rich to get richer, and cutting everyone else out. So, isn’t there merit in having taken on the challenge?

With this perspective, r/wallstreetbets won a moral victory after whihc at least some of its members could have earned a life-changing sum. Instead, they decided to “hold” their shares, apparently with the sole purpose of proving a point that the financial system is broken and unjust, as well as intrinsically absurd, but not immune from challenges.

What is the “lesson learned” from the Reddit vs Wall Street quarrel? It is clear that the financial world will not reform itself which, from a cynical viewpoint, is perfectly understandable. If given the chance to make virtually endless money, who would worry about the “moral grey area”? This is all the more true as money does not buy only goods and services anymore, it can buy political power and strategic influence, too.

So, what are some useful measures that can make the stock market “less of a casino“? How can it become more of a place where people invest in companies they actually believe in?

Reviewing the Practice of “Short Selling”

Apart from moral considerations on profiting from someone else’s demise, “short selling” can also stunt innovation. Recent research tries to prove that short selling can actually boost competitiveness because it would have the merit of ousting out of the market companies that are not performing particularly well.

What it does not take into account is that, when a large company (like GameStop) goes out of business, thousands of jobs are lost. This kind of research also fails to consider that many of these companies could actually be saved by investing in them the same money that is invested against them.

But is a full ban on short-selling necessary? Duncan Lamont, from Schroders, makes a convincing case against that by claiming that “short selling does not directly undermine the health of a company any more than buying its shares improves its fundamentals“. In other words: a heavily regulated, ethical short-sell is possible but it requires banning some problematic related practices. For example, generating negative publicity for a company whose shares the investor wants to short-sell.

Regulating Influencer-Led Investments

Reddit vs Wall Street
Elon Musk is known to be able to influence the stock market via Twitter. Lately, he’s been advocating the cryptocurrency “Dogecoin”. Source: CoinDesk

Alessandro Graziani from “Il Sole 24 ore” suggested a new legislative framework for the “new forms of solicitation to saving”. Nowadays, influencers can point small investors towards buying certain specific stocks, meaning that one Elon Musks tweet is all it took to make Dogecoin’s value raise by 800%.

As a result, it is possible that a huge mass of money may be directed towards only a few stocks or that certain shares may rapidly gain value to the detriment of others. In both cases, the main consequence would be that the value of said stocks, artificially inflated, may raise far beyond their “real” value. Such spikes in value are unsustainable in the long-term.

At first glance, this measure would seem to favor big investors and remove the threat of “influencer-led” investments, which increase volatility. Upon closer examination, however, it seems that such a measure could protect small investors, too. When the goal is to save money, financial stability is a fundamental facilitating factor. Market volatility gives Redditors as well as institutional investors the thrill of using the stock market as a casino, but more careful, long-term investors cannot afford to lose their money on a bet.

Explaining Reddit vs. Wall Street

In the end, beyond considerations on the ethics of speculative investment, it must be noted that it is ever more widespread. Opening the financial market to a broader number of people means, among other things, that elements other than sheer financial gain enter the decision-making game.

This case demonstrated that, notwithstanding the potential backlash on their finances, ‘small investors’ are willing to manifest their grievances by manipulating (in an ostensibly spontaneous manner) the stock market. The reason for their perceived unity is quite clear: to different extents, it appears that, in general, Redditors (and many of their sympathizers) feel like they have been let down, or even betrayed, at some point in their lives.

Many lost jobs or houses during the 2007 financial crisis, and resent banks and financial markets. Some have found it hard to get back on their feet, while others haven’t. In any case, there is arguably a socio-economic grievance behind the Reddit vs. Wall Street confrontation. Thus, when all of a sudden common people were able to figure how to “beat the house”, they did not hesitate.

Why This Should Matter to Policy-Makers

It is still unclear whether, when, or with what consequences this bubble will burst, but this incident suggests that there may be others in the future if the behavior of all investors is not regulated. After all, not everyone has a specific grievance. Some amateur investors are just in it for the thrill of a bet and may behave recklessly while some institutions may simply try to earn extra returns, which ultimately has the same consequences.

Instability benefits neither group and is detrimental to more conservative, small investors. For this reason, addressing this new, ‘enlarged’ financial market should be a priority going forward. For now, the “short squeeze” has only concerned private companies that had “short” positions but there have already been situations where that the object of short selling was an event, for example, the referendum over Brexit.

Political events are, therefore, not immune to speculation, but they are very vulnerable to instability. As a consequence, it is clear that in the near future the shortcomings of the financial market need to be addressed policy-wise. While the financial market will likely continue to exist for some time, it does not need to be unbalanced, unjust, or irrational.

  • Is it possible to reform the stock market, or will it always favor the stronger player?
  • Will the “GameStop bubble” eventually burst? If so, what will the consequences be?
  • What other regulations could help in order to avoid similar cases in the future?

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