That’s the headline the Canberra Times gave to my article on the implications of the recent short squeezes on Gamestop and AMC . It’s uninformative, but maybe more clickworthy than WallStreetBets and financialised capitalism, the title I gave to the early version posted here. With a bit esprit d’escalier and ignoring word constraints, I’d now go for “You wouldn’t let a bookie manage your home finance, so why let a casino plan our national investment”.
Canberra Times is paywalled, so I’m putting the text over the fold. We should soon resume the standard model where articles are published first in Inside Story (free), then reproduced (with a new headline, natch) in the Canberra Times
What does a fortnight of turbulence in the US sharemarkets tell us about the operation of the sharemarkets in countries — including the United States and, to a lesser extent, Australia — where the finance sector plays an increasingly outsized role?
In recent weeks, US sharemarkets have been thrown into chaos by a group of small-scale speculators gathered on a subgroup of the Reddit social media site called WallStreetBets. With coordinated buying of shares, they have bid up the prices of shares in GameStop, a computer games shop, and AMC, a struggling theatre chain. Both companies had been subject to extensive “short selling” by large investment managers, most notably Melvin Capital, a firm based in New York with assets of $8 billion.
Short-sellers sell shares they have borrowed rather than bought. Their hope is that they will be able to repurchase the shares at a lower price by the time they need to be returned to the lender. (In an older form of short selling, the “naked short,” speculators simply sold shares without a covering borrowing, hoping to cover their positions in time to deliver the shares they had promised. This practise was banned after the global financial crisis.)
By bidding up the price of Gamestop and AMC, the Redditors executed a “short squeeze,” forcing Melvin Capital and other short sellers to buy at much higher prices the shares they had borrowed and then sold. The short sellers lost billions of dollars in the process.
For most of the participants in this attack, the sharemarket looks like a casino rigged in favour of the big operators. The short squeeze was their chance to turn the tables, much as Tom Cruise’s character did on casinos in the movie Rain Man.
The view that the sharemarket was rigged gained credence when the online brokerage Robinhood, used by many of the Redditors, halted trading in Gamestop, AMC and other securities. According to Robinhood, the restrictions became necessary after clearing houses raising the required capital reserves it needed to hold in order to execute share trades. This Redditor response, quoted in the New York Times, was typical: “We’re living in a system where there’s no such thing as justice anymore and the entire world is falling apart. Nothing really matters, so we might as well try to have fun while we’re here.”
As the action subsided, it became clear that, for the most part, the big guys had won again. Large-scale investors who held shares in the companies before the squeeze began were able to sell part of their holdings, reaping massive profits.
Thanks to the increase in its share price, AMC was able to issue new shares, using the proceeds to repay debt and thereby stave off impending bankruptcy. AMC’s bounceback showed that the sharemarket is not simply a casino, even if many participants view it that way. Corporations depend on equity capital to provide the capital they need for investment and this is ultimately raised by selling shares.
Most of the time this link is obscured. New investment is typically financed from retained earnings rather than new share issues. But the capacity of firms to borrow depends on their sharemarket value. And if a firm’s share price is below the value of its capital, it will be a target for takeover with the assets being stripped and sold.
More importantly, perhaps, AMC’s luck in being the target of the short squeeze meant the difference between survival and 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 sharemarkets. The idea is that investors direct equity capital to those corporations that can put it to its most profitable use.
The efficient markets hypothesis, the bedrock theory of modern financialised capitalism, says that sharemarkets do the best possible job of estimating the value of assets, and thereby guides the allocation of capital. Before the WallStreetBets push, the market had judged 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, a short-selling raid) can be organised, and potentially profit, any group of traders who can mobilise the necessary few billion dollars (using options, those billions can be magnified a fair way). That’s part of the reason why share prices are far more volatile than would seem justified by the arrival of new information relative to future earnings.
If share prices are more volatile than underlying value, the two must differ most of the time — a fact that undermines the frequent claim that financial markets do a better job of allocating investment capital than a government enterprise, for example, using the techniques of benefit–cost analysis to choose its projects. And that, in turn, undermines the economic case for privatisation, which was central to the era of economic reform that began in the 1980s and 1990s and ended in the global financial crisis.
We haven’t yet worked out how to deal with the failed model under which we are still operating. But, as the greatest of all twentieth-century economists, John Maynard Keynes (himself a successful speculator), observed, “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” •