Game Stopped

This game will end in tears

Not Dead Yet

It's not often that a $250MM company becomes a 25B company basically overnight. It's even more rare that the company under examination is overlevered, generating losses, and whose industry faces a bleak future.

It is these and other attributes which saw Gamestop become the target of short sellers, financial market participants who profit when prices fall.

There's something in the human psyche that objects to short selling; perhaps it's our innate sense that we shouldn't take pleasure or seek benefit in others' misfortune. Of course, whenever we bet on a single stock to perform well, we implicitly place a bet against all its competitors: to buy Mastercard is to bet against Visa, to borrow one example from a prominent duopoly. Therefore, to be an investor is to be a short seller, in a way.

So it would seem that betting against a company outright should be the moral or ethical equivalent of not investing in a company. We might engage in theological quibbles over whether the former would be a sin of the commission, while the latter one of the omission variety. When one profits from a company's misfortune, one is inclined to harbor malevolence toward it, and it is our societal prohibition against wishing harm on someone to which short selling seems to be an affront.

In addition, short selling involves the employment of leverage, or the borrowing of money, to effect the trade strategy. Everyone knows that borrowing money is bad. And so borrowing money to bet against a company must be really bad. (Employing leverage to buy more of a stock than you could otherwise is similarly perceived as imprudent at best, and downright greedy at worst.)

However, there is another compelling argument for the allowance of short selling, and that is that a private vice can result in a public benefit. For our readers who are not familiar with Bernard Mandeville's Fable of the Bees, quite briefly the argument dates back to before the founding of modern economics, and runs like this: individual citizens who engage in unsavory behavior can nonetheless produce a public benefit in aggregate. Thievery necessitates locks, and therefore the production of locks, keys and the employment of locksmiths. Everyone in society benefits from an increase in the size of the economic pie.

Short selling performs two valuable functions in the financial markets: first, it provides price discovery, or the market-based determination of what something is worth; second, it provides a means by which fraud and self-dealing can be thwarted by market participants themselves. One person's interest payment is another person's income, and so the taking of leverage in support of these strategies provides an additional, if incidental, benefit. Short selling, even on a levered basis, is therefore critical to the efficient functioning of markets, and sometimes the destructive agent in the creative destruction aspect of modern market capitalism.

And so it is that the current controversy concerning Gamestop has all the makings of a Medieval morality play. The hacks in the financial press have lazily framed the debate as one of the moneyed elites (played by institutional investors) versus the virtuous citizenry (played by retail investors) who do battle on an Ivanhoe-inspired field for the fate of the realm.

goodstead has earlier written that the most important dynamic we are witness to in our time is the current struggle between the forces of Populism and what can be generously referred to as the forces (or rather, non-forces, entropy) of Elitism. But the Gamestop drama isn't emblematic of this conflict. The institutional investors betting against Gamestop also manage the money of foundations and endowments that provide direct and indirect support to those set adrift by the vicissitudes of the modern economy; the retail investors to which they are opposed are wealthy enough to pass the suitability requirements necessary to trade complex derivative products and employ substantial leverage in their brokerage accounts. Both are trying to make money--although only one seems to have a persecution complex, or to believe that their economic jihad is just. This isn't a tale of the inveterate hatred of the rustbelt factory worker for the Wall Street titan. It's more Haute Bourgeoisie versus Petite Bourgeoisie; this is intra-class struggle, rather than real class warfare.

Unfortunately, like all conflicts, there is collateral damage. Financial markets operate less efficiently the more price diverges from intrinsic value. If speculative positions are targeted because they are speculative, then speculators will withdraw liquidity from the market, making it more expensive for hedgers to hedge. More worryingly, resources are inefficiently allocated when a company like Gamestop, which sports an extraordinary amount of debt relative to its income, can obtain debt in the capital markets that would otherwise go to a company that would put it to more productive use, and thereby increase the size of the economic pie to the benefit of all. Instead, a zombie company will lumber on, enriching the executives that drove it into the ground in the first place, everywhere serving as a memento mori to those who would try to ensure the proper functioning of the capital markets.

At goodstead, we are on the side of the individual investor, whom we see as being ill-served by the developments around these companies. Silver, a goodstead favorite, is now seeing price gains off the back of this attention. While beneficial for our clients' portfolio, higher prices for silver raise the cost of solar panels, which raises the cost of switching to a renewable energy future, an unacceptable tradeoff in our opinion. The activities of the r/wallstreetbets crowd have hurt individual investors by increasing financial instability, the cost of trading, and the reliability of financial market's price setting function. If the object really were to punish the Masters of the Universe, then the r/wallstreetbets community should buy companies in which they really believe, and then hold them. This would deprive Wall Street of income from trading commissions and margin loans, and ensure that the companies that can productively use capital have proper access to it.

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