Frenzy

Some were quick to characterize the phenomenon as a rebellion of amateurs against professionals, even of millennials against boomers. That might be romanticizing what is really a failure of regulators to anticipate technology-driven changes in the market.

The phenomenon involves the surge in the price of GameStop stocks in the US market. “Surge” might be an understatement. In a space of a couple of weeks, the price of this particular stock (and several others, although less dramatically) rocketed over 2,000 percent before settling down at several hundred times original value.

GameStop is a brick-and-mortar gadget retailer with several thousand outlets usually located in malls across the US. Because of the lockdown and the anemic economy, it began losing money. That made it a target for large hedge funds making money out of “shorting” stocks.

“Shorting” stocks is a market play where traders bet a stock’s price is going to drop. They begin selling the stock at less than market value. When the market reacts by dumping the stock, the price falls even more. The “short” sellers then buy back the stock at even lower prices, pocketing the difference. At times, the stocks that are “shorted” are just borrowed and returned a short while after.

“Shorting” a stock might seem unethical, but it is perfectly legal. It is a bet accepted by counterparties betting the other way.

When the hedge funds began “shorting” GameStop stocks, tens of thousands of amateur day traders began buying up the stock, forcing up its price. They were betting the other way for no other reason than to “burn” the hedge funds. One such fund, despite its army of “quants” (quantitative analysts often supported by artificial intelligence), was reported to have lost a lot because the stock went up rather than down.

The game of “shorting” stocks is time bound. The one selling stocks down agrees to buy them back at a specified (often short) time. Otherwise no one will take up the bet, especially if it involves a brick-and-mortar enterprise whose business model is probably obsolete.

The hedge funds that lost money the past few days were due to buy back stocks they expected to be cheaper. Instead, the stocks were priced several hundred times their value.

What happened, in this case, is probably a perfect storm that might be hard to replicate anywhere else. It is certainly unlikely to happen here, given the small number of amateur day traders buying and selling stocks on their laptops. Also, because stock trading in the Philippines is beset with much friction such as high commissions charged by brokers and taxes levied on earnings.

The perfect storm involving GameStop stocks is due to a unique combination of factors.

First, US stocks were surging even as the economy was declining. With very low interest rates, savers were avoiding fixed income paper and venturing into speculative equities play. This is the reason Wall Street has been booming while Main Street was distressed. Last year, America’s billionaires made trillions from the boom in their stock prices (think Tesla, now with bigger market capitalization than all the traditional car companies combined).

Second, with large online trading platforms, millions were able to trade stocks from their homes. These small investors actually form a community of participants in extensive chat groups that evolved its own dialect – and eventually its own unique attitude towards stock trading. A surprising number are YOLOs (you only live once), who care very little for the money they have in play and often bet their entire life savings on a risky stock.

Third, in-depth investigation shows that many participating in this stock “rebellion” were using money from their stimulus checks. What was supposed to fuel activity in the real economy detoured to the speculative economy, supporting the surge in stock prices and making the wealthy even wealthier.

Fourth, this stock frenzy is driven by some sort of Trumpian disdain for experts and the “elite.” This is like the know-nothing Red Guards, running amuck in the streets. This sort of frenzy will only widen the chasm between the hard facts of the real economy and the fanciful speculation of amateur traders.

Although the more gullible might want to characterize this event as some sort of class war, it is actually nothing more than a warp in an inadequately regulated market economy. At some point, the prices of the stocks manipulated by way of chat groups will return to their real-world value, burning the small investors after scarring the large hedge funds.

However, the hedge funds will survive and the small investors will be wiped out by their own folly.

There is a much larger, much stranger phenomenon going on.

It never seemed correct that while the economy was contracting, the stock market was booming. The New York Stock Exchange broke records over the past year while unemployment was at record highs, people were going hungry, the pandemic was turning worse and millions face eviction for failure to pay rent. Yet, instead of paying rent or buying food, amateurs tried their hand at manipulating stock prices, putting at risk all the money they had.

These amateurs toying with stock prices are like the mob that stormed the US Capitol. They have been nurtured during a truth-defying era.

As the chasm between stock speculation and the horrors of the real economy widens, we could be seeing a serious bubble forming. That could never be a good thing.

When stock bubbles burst, they often take the real economy down with them.