It’s been hard to miss the chaos that’s arisen from a bunch of Reddit users (on sub-reddit WallStreetBets) getting together to squeeze shortsellers on stocks including GameStop and AMC Theatres. Most of the attention has been confined to the stockmarket action, but I was struck by this piece in The Bulwark[1], making the point that the process has enabled AMC to issue high-priced shares, repay debt and thereby stave off impending bankruptcy.
I don’t have a view on whether AMC should go bankrupt or not, but this is the kind of decision about capital allocation that is driven, in large measure by stockmarkets. The efficient markets hypothesis says that stockmarkets do the best possible job of estimating the value of assets, and thereby guides the allocation of capital. In the absence of the WallStreetBets push, it appeared that the market judgement was that it would be better to steer capital away from AMC, and into some other activity. Now, it’s the opposite.
One possible response is that WallStreetBets is an episode of craziness that will soon pass. But once you strip away newsworthy bits like the role of Reddit and the scale of the price movement, this kind of squeeze (or conversely, short-selling raid) is available, and potentially profitable, to any group of traders who can mobilize the necessary few billion (using options, those billions can be magnified a fair way). That’s part of the reason why stock prices are far more volatile than would seem justified by the arrival of new information relative to future earnings.
If stock prices are more volatile than underlying value, the two must differ most of the time. That undermines the claim that financial markets do a better job of allocating investment capital than would, for example, a central planning board. Even if you don’t want to go that far, there’s no obvious reason why limiting stock trading to (say) once a week would impair the allocation of capital to an extent that would outweigh the savings from cutting the financial down to a small fraction of its present size.
fn1. A Never-Trump website, well worth a look.
John Quiggin 
The physical trading floor of the London Metal Exchange is only open for short periods, though it backstops bigger 24h electronic and telephone trading (https://www.lme.com/-/media/Files/Education-and-events/Online-resources/Brochures/LME-guides/Detailed-Guide-to-the-LME.pdf?la=en-GB):
“• Metals are traded in five-minute sessions (called Rings) to ensure concentrated liquidity.
• The Ring hosts two trading sessions, one in the morning and one in the afternoon. There are two Rings per metal in each session and trading ends with a closing 30-minute “Kerb”, in which all metals can be traded at once.”
That’s a maximum 50 minutes floor trading per day for a particular metal.
These markets are much more closely connected to physical exchange than those for securities – the LME licenses 550 warehouses around the world. I imagine the industrialists buying and selling copper are not keen on the artificial volatility that suits speculators and traders.
JQ’s point about irrational prices extends in a weaker form to the medium term. The slide in the stock price of say Exxon-Mobil makes sense in terms of fundamentals. But look at Tesla. A year ago its market cap was $143 bn, today it’s $752 bn (x 5.3). Tesla had a good trading year, sure, though nothing spectacular.: it sold 36% more cars in 2020 over 2019. But it’s the same company: same management, strategy, model line up, markets, and technology (with steady incremental improvements). You have to think that it was either undervalued a year ago, or is overvalued now, or both.
How do you solve the coordination problem of getting a group of independent investors to gang up on a group of short-sellers? If I was one of these investors who had seen GameStock go from $15 to something north of $300 I’d be tempted to sell. Moreover, that would have shown foresight given that GameStock has now collapsed to less than $100. I find it hard to believe that such collaborations will work.
Even with deep pockets and a single buyer, it’s hard to “hold up” the market- I recall the fiasco of the Hunt Bros trying to corner the world silver market. People are aware of the limits of market power in huge securities markets.
On the efficient markets hypothesis: Does this imply stocks will reflect their “intrinsic value” (expected value of discounted profits) or that the stock price is just unpredictable – you cannot use information about past behavior to deduce where the stock price is going? the latter interpretation is true almost by definition – if you could forecast you would use that info up to the point where the information had no value.
I think the latter interpretation makes the most sense. We know that we are in a bubble at present but that doesn’t mean it is sensible to short because we don’t know when the “greater fools-pass the parcel” trading will end. I quizzed an eminent Australian economist on how to handle my investments during a bubble when I was making a stack of money each week by going along with speculative nonsense and his sensible response was “sell half” and then keep on averaging down. I think this outperforms the most erudite financial theory.
Harry,
The Redditers solved the coordination problem for one stock attack (or a few) for a period of time. But you are correct in saying that this coordination solution cannot be sustained indefinitely or universally. It seems to relate to the issue of shared goals and non-shared goals (personal goals). People herd, or can be herded, to a degree and then they tend to splinter again. I like the Napoleonic era military metaphor. A formation maintains discipline in action while certain conditions are met. Esprit de corps or morale facilitate coordinated action (along with command and control of course). The rank and file’s conscious identification is with the corp; the flags, the formation-body, the “glory” of the corp.
However, in battle actions, with battle stress, we see two “contagions” which can break up discipline. The first contagion is fear related to self-preservation issues. The identification with the group is lost under heavy action and the individual returns to identification with himself as his prime focus. When morale breaks, in contagion fashion, more and more individuals break from the formation. Eventually, the breaking becomes general and the formation retreats in rout. This is quite difficult from a disciplined, staged retreat. On the other hand when a formation is “too successful” they break forward in an undisciplined foot charge. Again, the individuals start operating on individual animal spirits rather than on coordinated action principles. An undisciplined break forward is to be feared almost as much as a rout precisely because it can so often can be turned into a rout by a disciplinde defense or counter charge, especially by the cavalry, on the other side.
I have more to say on your post and the original post but I don’t have the time now. I will get back to it.
Ikonoclast, Asking around I find the only explanation for the temporary coordination was that the ignorant were being led by the nose. Hard to believe. If I was playing this game I’d be tempted to cash in a bit just to secure my gains.
crikey……remember bunker hunt?
I agree with J.Q.’s original post in the sense that we need more financial regulation. I actually see no valid reason for the existence of “shorts” at all… or many other complicated financial instruments. They are there for speculation not for productive investment. I’m in favor of strong regulation of markets, especially financial markets. I am in favor of much more statist central planning for natural monopolies and for health, welfare. education and social issues (to name four). I’m also in favor of more real resource planning and costing (in ecological, quantity surveying and opportunity cost terms) and against the aggregating and comparing of the incommensurable in dollar value terms. People who have read Capital as Power (the book and the articles) will know what I mean.
I’ll have more to say about money printing, asset inflation and crypto-currency inflation if I can get my capitalist investor son to help me write a post. His viewpoint is very interesting even though I am an armchair socialist and he is a computer chair investor-capitalist: the first being a non-participant in the socialist struggle and the latter being a real participant in modern financialized capitalist praxis.
I was once talking to a guy from a hedge fund, they cruise around like sharks looking for opportunities where the market had mispriced the business. He said that they win about 1 in 7, the wins must be substantial.
You need a lot of cash for the shorting game, and nerves of steel.
akarog and Iconoclast, Unless they invest in mutual funds or ETFs every investor is looking for mispriced assets. The distinctive thing on the shorting side is that the mispricing is an overpricing. Maybe “sharks” is one way of describing them but Glaucous Research, who targeted Blue Sky Alternative Investments, did the investment community a favor. The general favor provided is that boards and managers face restrictions on their ability to deceive.
https://www.businessnewsaustralia.com/articles/the-rise-and-fall-of-blue-sky–a-timeline-from-asx-powerhouse-to-pariah.html
Harry,
I am more in the position of having an analogically and heuristically based complex systems opinion rather than having knowledge about the intricacies of shorting and other market instruments. Having said that, my opinion is as follows. More and/or better market regulation and company regulation could replace some or all of the need for shorting (specifically).
If too many people are getting shot, we can try America’s approach of letting everybody buy a gun for self defense (ostensibly) or we can try Australia’s approach of heavily regulating gun ownership. The empirical facts show that Australia’s approach works far better. If too many people are not doing proper company reporting and/or hyping companies in dubious ways and/or gambling too much on stocks then we can add another layer of market gambling (shorting as an example) or we can more strongly regulate company behavior and the market itself. I would go for more company controls and market regulation.
If we add to many layers of financial instruments, it seems to me the situation for the market is like that of a patient taking too many medications. Pharmacological interactions of too many medications become complexly and unpredictably dangerous. Financial interactions of too many financial instruments, I posit, will also become complexly, unpredictably dangerous and destabilizing. My complex systems management heuristic in each case would be to simplify systemic treatment itself by simplifying and reducing the cross-treatments, the reinforcing-treaments and the ad hoc treatments applied to and across the system.
I notice often enough that the special pleading for special instruments comes from those who benefit most from them and even game said instruments. That’s certainly true of my investor son. Maybe he knows a lot more than I do (he does in many ways) but maybe he is also prone, like all humans, to motivated reasoning from personal interest. What about the 99% who can’t, don’t or won’t play the investment game at the more casino-style levels? Perhaps they should be listened to in the interests of more equality and stability in the entire system?
2 thoughts:
EMH – efficient over long run not at every time point. The reddit flashmob are already losing their pants. (Poor buggers – stay away from what you don’t know)
Restrict trading to once per week – derivative traders would make an absolute killing. Is that what we want?
I suspect that the volatility of sharemarkets today has more to do with the salary packages of company executives. Now that they get options to buy shares in their own company they gave a vested interest in maintain growth on that company’s share price. Up against them are the hedge funds that look for weaknesses on balance sheets. It’s is like the Moon’s effect on tides. The closer the Moon gets to Earth the bigger the variance between high tide and low tide. Of course in this analogy the Moon is greed. The greedier the executives get to cash out their options trades, the more they will pull up the share price of their company’s stock. This can be done by buybacks and retrenchments. But hedge funds will look at the leveraged debt on the balance sheet. If they detect any excessively leveraged position via the company’s balance sheet, they will short that stock. As my Welfare Economics tutor told me long ago, such people are greedy grasping individualists.
By the way short selling has two main forms. The mass media does not know the difference between naked short selling (illegal in many countries) and covered short selling. I explained it once to my students this way Naked short selling is like stealing a car, keeping the plates, selling the car then buying a replacement cheaply. If you can get the car back before it’s missed you pocket the profit. If not you go to jail.
Whereas covered short selling ( common in most share markets) is where you ask the car owner if you can sell their car but promise to replace the car at a latter date AND split the profit made on the two transactions. You only lose here if you cannot get the replacement car for less money than the money you got from the sale of the first car.
Of course on the share market the share trades are in the tens of millions of dollars per short sell. There are also nano trades that occur so quickly that the owner of the shares may not even notice the loss of shares from their portfolio.
Sometimes short selling is programmed into share trading computer trading protocols. So there may be no human oversight.
Scary stuff!
weakness
“Everything should be made as simple as possible, but not simpler.” – Attributed to Albert Einstein.
This can be taken as a theory statement and a practical statement. On the theory side, a precursor statement has it:
“It can scarcely be denied that the supreme goal of all theory is to make the irreducible basic elements as simple and as few as possible without having to surrender the adequate representation of a single datum of experience.” – From “On the Method of Theoretical Physics,” the Herbert Spencer Lecture, Oxford, June 10, 1933. This is the Oxford University’ Press version.
Einstein’s attributed statement can be taken either way, as theoretical or practical. Why are the financial markets so complex? Do they need to be as complex as they currently are to facilitate necessary productive investment? (Which isn’t happening by the way or America’s infrastructure would not be crumbling and their health system non-existent except for the rich.) Or do financial markets need to be as complex as they currently are to facilitate multiple layers of financial system gaming: gaming the system? The answer is the latter and it is as plain as the nose on Cyrano De Bergerac’s face. The excess complexity is there for gaming the system. I am certain John Quiggin, Ernestine Gross, Steve Keene and Bill Mitchell agree with me or rather me with them on that score. That’s a decent swag of progressive Australian economists; i.e. economists who are not in the pockets or on the payrolls of the neoliberals and capitalists.
“The mutual reinforcement of debt and share prices is a closed circle, and so the world of money is decoupled from the real world, in which most people struggle, and leads eventually to a handful of super funds owning virtually everything”. – Yanis Varoufakis.
I have been forming a similar view in the last several years. There seems to be an arising of, or an intensification of, dual circuits of money circulation in capitalism.
There is a saying, that “Quality is more important than quantity.” The antithesis is that “Quantity has a quality of Its own.” A great enough quantity of something develops qualities all of its own. The physics of ripples and tsunamis or of small scale models and large originals are very different in some respects, precisely because of changes in the differentials of the forces and dimensions involved.
We see this kind of thing with money to in that increasing quantities lead to qualitative differences. One important cross-over point occurs where quantities of money change from the income and (sometimes) asset amounts necessary for subsistence or even middle class existence to the amounts which exceed the cost of the reproduction of labor and the reproduction of middle class existence. Money in quantity becomes qualitatively different when it is no longer required in the main for subsistence, middle class existence or even elite existence. Differentials in marginal propensity to spend are one of the expressions of this. This corrollary is the differentials in the marginal propensity, or even the ability, to invest.
This phenomenon can generate two circuits of money circulation. They are connected by certain flows but the main circulation of each continues within its own circuit. The FIRE circuit feeds itself by, Q.E. these days, but also by surpluses it can draw in from the consumer circuit which is continually topped up by wages and welfare. Thus, the FIRE sector keeps lifting its level absolutely and differentially by Q.E. and corporate welfare but also by drawing surpluses out of the consumer circuit.
The semi-quarantine of finance circuits from consumer circuits, plus intentional wage suppression and the fortuitous hedonic gains and costs savings from technological advance, permit basic consumer inflation, for goods below luxury standard, to be kept relatively low, thus keeping bread and circuses within the reach of ordinary consumers.
Meanwhile, the finance circuits are free to absorb money printing and Q.E. and to inflate asset prices. Reasoning to extremes, this process can continue until all assets are priced out of the reach of the poor, working and even middle classes although these last two at least could still afford bread (subsistence) and some access to the diversions, entertainments and circuses of modern life. We would see eventually no ownership of assets by any class below the genuinely rich, who are maybe just the 1%.
Differentially, to the rich, if assets double in price, but their accumulation of numéraire denominated wealth quadruples then they become twice as wealthy as before but the non-rich will concomitantly become poorer, losing all asset wealth over time as all ownership transfers to the rich. The poor and even “middle class” in this system will eventually be required to rent and lease everything they need except immediate consumables like food and maybe clothing . This is where I see the current system heading if it operates substantially unchanged and there are no major revolutions or wars.
I am a bit behind in this discussion. Apologies if I repeat a point that has already been made.
On the broad question of central planning vs decentralised decision making. No, a central planning board (for all of the world?) is not what I’d consider to be a reasonable alternative to securities markets. But having a public planning board for water supply in Sydney or NSW or the Murray-Darling in a democratic society is fine with me. In a decentralised system there are many planning boards range from an individual to households to corporate headquarters.
Efficient capital market belief. Ostensibly, neither the short selling corporations nor the so-called Reddit crowd think much of it.
The so-called Reddit crowd has been described as ‘mug punters’ (Stephen Bartolomeusz), ‘retail investors’, ‘day traders’, ‘Generation Z traders’ (eg Sahra Danckert, smh).
Some members of the so-called Gen Z traders speak of democratisation of the financial system. Idealistic phantasy? Newspaper authors voice the opinion that the “revolt by the masses will be short lived.” (eg Bartolomeusz, smh).
In my opinion, there is a link between the idea of democracy and the idea of a market economy. In the ideal version of the latter, every individual member of a society can participate in ‘the market’ (given the assumption of minimum wealth constraint, as described many times before on this blogsite and as can be verified by studying the existence proofs of GE models). Similarly, one core element of the idea of democracy is equal participation of the members of the society. One difference is that in a democracy the basic rule is one head one vote, while in a market economy it is one unit of wealth one vote. Depending on the distribution of wealth, this difference may matter or it may not. (Equal wealth distribution is not necessary to achieve a satisfactory outcome; eg 10 people with each having 10 percent of the wealth of 1 ‘high wealth’ individual for each ‘high wealth individual’ may have the same impact on prices.)
Empirically observable democracies differ in their rules of implementing the basic idea of one head one vote and, according to some analysts, some are considered ‘better’ than others. Similarly, empirically observable financial markets do not necessarily correspond to the conditions in the ideal market economy.
Is there a plausible reason for a ‘revolt against Wall Street’?
Yes. The transactions costs (assumed to be zero in finance and economic models) excludes low wealth individuals in participating. My best information on transactions costs in the US share market is a fixed cost of $10 for each trade. This $10 is a fixed cost per trade. $10 becomes increasingly negligible as the amount transacted increases and vice versa. This exclusion of low wealth individuals from investing their relatively small savings in a manner they see fit in the only segment of the financial system which produced high rates of return does increase wealth inequality.
The trading platform Robinhood, in existence since 2014, offers zero transaction costs. (It makes its money by bundling the individual transactions and selling them on to WallStreet brokers at a fee.) This platform was created by two people from Stanford University (known for having many finance graduates) who worked on Wall Street before creating this platform. They are said to have coined the term ‘democratisation’ of Wall Street.
This innovation changed the institutional environment.
The WallStreetbets play against hedge funds involved the Robinhood trading platform.
Robinhood had to close trading in GameStop temporarily because its financial limits had been reached.
Harry asked, how did the retail investors coordinate their (successful) strategy against one or several hedge funds?
I suspect a lot will be written after analysts read the many posts on Reddit. However, from what has been reported so far, it seems to me, the share price rally against the short selling hedge fund(s) relied on very similar factors to that on which short selling hedge funds make their money, with one disadvantage, namely the ‘planning board’ of the Reddit ‘crowd,’ say Roaring Kitty, is in public view while the ‘planning board’ of a hedge fund is a corporate boardroom.
The similarities include:
1. Information provided to the market. Via Reddit in one case and via investment advice letters in the other.
2. Everybody in finance knows that a lot of trades are initiated by automated buy and sell orders. (The weight of the individual buy orders for say GameStop swamped the sell orders of the hedge funds.)
3. There are some traders who use technical analysis, which relies on share price movements.
Re JQ’s post: “Most of the attention has been confined to the stockmarket action, but I was struck by this piece in The Bulwark[1], making the point that the process has enabled AMC to issue high-priced shares, repay debt and thereby stave off impending bankruptcy.”
Well, from a GE perspective all markets are related. And yes, financial risk (debt) is a source of bankruptcy and yes, the capital structure (the ratio of debt to equity in the financing of a business) does matter.
The so-called chaos that followed the Reddit-Robinhood play is no more than observing the consequences of ‘big players’ strategies not working. They have to cover their losses by borrowing and by selling shares in other companies. All prices are related.
Several articles in the press and elsewhere, exhibit a rather paternalistic attitude toward the individual traders – they will lose money. Some may, some may be fine with it because they don’t see having spent money on a car implies having lost money so why should spending money on investing in a company one likes should be a problem, other will have made a profit and others may refine their methods and ‘high finance’ may compete with the individuals on the Robinhood platform. Lets see what happens.
Nobody can observe the ‘fundamental value’ of a company. Price/earning ratios are sometimes used in the context of fundamental value – but these ratios only serve comparisons of companies classified to belong to the same industry. Discounted cashflows is sometimes used in the context of fundamental value. This methods may be helpful for organising data and help to coordinate expectations on, say a corporate board. But these calculations do not reveal the ‘fundamental value’ (except by misnomer). The numbers in the numerator are not observable. They are based on management forecasts, or explicit assumptions about some parameters or by a consulting company or by the corporate planning board of a potential raider or by powerful shareholders on corporate board. (In Finance texts and case studies, the numbers to be plugged into the equation are easily discovered by reading the text – they are made-up numbers.)
In the idealised market economy, the fundamental value depends on individuals’ preferences, on technological knowhow and the wealth distribution.
I read the OECD is discussing a financial transactions tax to slow down the speed of transactions. Assuming this long term aim of the EU is finally coming to fruition, I do hope the tax will be levied on the total amount of a transaction rather than on the number of transactions.
I know that this is long after the fact, but I just want to point out that one of the reasons the temporary coordination held was because GameStop had been shorted to over 100% of its value (I think as high as 140%). I think people also knew the dates that those buy contacts were due. This meant that everyone who held shares knew that they could sell and were pretty confident that the price would be high at that time, because demand was guaranteed to exceed supply.
seqaugur says: “shorted to over 100% of its value (I think as high as 140%)”
Not quite, sequaugur.
A covered short sale involves a temporary contractual loan of shares (a number of shares NOT A VALUE). This contract involves a time period of the loan, a fee, and the number of shares.
A naked short sale involves selling shares for which there is no loan contract, potentially more than the number of shares on issue.
See Gregory J. McKenzie’s post above as to how a naked short sale can come about even though nobody intended to steal a share temporarily (or otherwise).
The justification for allowing short selling, offered by finance practitioners and some finance academics, is
a) short sellers offer liquidity to the market (this is hardly a relevant factor when financial markets are awash with cash).
b) price discovery (this strikes me as particularly silly when offered by people who at the same time promote the idea of ‘capital market efficiency’). In support of this argument, the odd case is referred to where hedgefunds had discovered a financial recording problem (eg Enron). But why did they not advice the authorities or the public at large? Surely, such discoveries involve more than the price of a share.
The only reason I can think of for allowing a very small fraction of shares on issue for covered short selling is to assist portfolio managers to solve a temporary portfolio choice problem at reduced costs. What is a ‘small fraction of shares on issue’? It should be small enough to not affect share prices ‘materially’ as in not more than a random daily change or not at all.
Been reading the 140% thing as well. It might be true indirectly. The hard well regulated limits only apply to classical short selling. There’s a very arcane world of derivatives out there, not just the well regulated futures, also obscure behind the doors dealings among professionals, to the retail investor rip off type. At the end of the day, those to need to cover. Remember the VW short squeeze ? Porsche bought tailored derivatives from banks (who in this case seemed to largely cover by buying the shares) to circumvent publication requirements. Come to think of it, the derivatives Adolf Merckle was sold probably were also part of the coverage.