Too big to fail, 2008, too small to win, 2021

In Oscar Wilde’s Lady Windemere’s Fan, Lord Darlington quips, “a cynic is a man who knows the price of everything and the value of nothing.” But maybe Lord Darlington has it all wrong? Perhaps the correlation between price and value is a lot shakier and more ethereal than we think? Last week’s action in the stock market, which pitted the ‘degenerates’ of Reddit’s WallStreetBets board, as they like to call themselves, against billion-dollar hedge fund manager Melvin Capital brought a whole new meaning to the term ‘value investing.’

Often companies like Melvin Capital try to make money shorting stocks. They do this by selling shares they do not own, hoping to repurchase them later at a lower price and inverting the normal purchasing process of buying low and selling high. Melvin Capital and their ilk have made billions by shorting and then bad mouthing companies to the media in hopes of driving down the price of the stock they have shorted. CNBC, Bloomberg, and Fox Business gladly give these hedge fund managers airtime because it’s compelling TV. Selling short can be particularly newsworthy because it places a bullseye squarely on the back of a targeted company.

Short selling can be a highly speculative trade as the upside is limited. A stock can only drop to zero and no further. The downside can be huge because a stock can rocket up, as Melvin Capital painfully discovered last week. Gamestop (GME) shot up from $19 to about $400 in a few weeks, while AMC Entertainment Holdings (AMC) went from $4 to $20 in the same amount of time. GME and AMC both found allies in the strangest of place – WallStreetBets, a Reddit board of stock traders, who decided to take on the hedge fund shorts and go long, which they did through their favorite trading app Robinhood. To say all trading hell broke loose last week would be a massive understatement.

Robbing the poor to save the rich

Without a fair market, there is no real value, and when one side places its hand on the trading scale to limit either buying or selling, they create an artificial market. Robinhood did just that. “In light of current market volatility, we are restricting transactions for certain securities to position closing only, including $AMC and $GME,” said a Robinhood tweet on Thursday morning. In other words, they throttled all buy orders and only allowed people to sell their GME and AMC shares, which had at that point been caught in a short squeeze. A short squeeze is a rapid price rise that can force out shorts as they get margin call demands to raise capital or buy back position. The share purchases they are forced to make then cause a further sharp rise in prices. Many cried foul and called Robinhood’s behavior the worst act of market manipulation they had ever seen, and I have to agree.

While Robinhood claims to be “democratizing finance for all,” it couldn’t have acted in a more unfair and undemocratic way. Cointelegraph reports: “According to a June report from the Financial Times, $39 million of Robinhood’s revenues from equities and options order flow came from Citadel Securities, a market maker sister firm of Citadel. At the time, this represented more than 35% of the trading platform’s revenues.” Citadel was one of the firms that came to Melvin Capital’s rescue, pumping in $2.75 billion to steady the short ship. Robinhood and Citadel’s chummy relationship certainly looked questionable from the outside. The trading app that sold itself on helping the little guy to play in Wall Street’s deep waters seems to have caved in to the big guy who was sitting on billions of dollars in short losses.

Robinhood’s claim that they had to halt trading in stocks like GME and AMC because of settlement issues doesn’t ring true. The last time I traded stocks, no broker extended me credit (beyond margin credit), and I had to fund my account before they would execute the trade. Stocks settle in three days, but the funds in my account are locked until that trade is settled. If the stock goes up, great; if it goes down, my broker might request additional funds for margin requirements. Sure, stocks fluctuate, and GME was going on a wild tear, but Robinhood should have throttled down the margin, not stopped trading altogether. Killing one side of the market looks exceptionally bad if you have fiduciary ties with some of the players who are getting killed on the short side of the trade. What seems to have happened is Robinhood tossed a lifeline to one of the companies that produce enormous profits for the company. Since this is America, the lawsuits are flying. Robinhood won’t be hurt financially as they have plenty of legalese in their user agreement to protect them, but the reputational damage will be enormous. The bigger story is the little guy, once again, gets screwed. As Elizabeth Stark, CEO of Lightning Labs, tweeted, “Too big to fail, 2008, too small to win, 2021.” “The game is rigged,” cried the critics, and who can argue with them?

An advertisement for Decentralized Finance

The Gamestop-Robinhood-Melvin Capital story could hardly be a better advertisement for decentralized finance (DeFi), blockchain, and prediction markets. All the things that make trading the GME market so tricky don’t exist in the crypto world. Shutting out buyers is anathema to the concept of a free and open market. It was an action so outrageous that even two politicians of polemically different stripes – Ted Cruz and AOC – agreed that something was amiss. China sometimes limits the selling of a stock or shorting of stocks to avoid severe stock downdrafts and even market crashes. One could argue this artificially inflates the stock prices, so never a good thing. Still, few have heard of a stock brokerage firm limiting buying to temper a stock’s rise. I’ve been investing for over 35 years and have never seen anything like that.

There is one thing upon which we can all probably agree. A free market means there should be no limits placed on stock trades unless something illegal is going on at the company or there is something suspicious about the market transactions. 

Honestly, it just seems anti-market, anti-the little guy, and anti-American. It’s another in a long line of examples where the little guy gets screwed because the big guy has the power to change the rules or move the goalposts. The reality is that WallStreetBets was only doing what the shorts had been doing all along; using their voice to drive the price of a stock. The shorts used the financial media while WallStreetBets created a community on Reddit that moved as one. This all proves that a decentralized market is the only fair place to be. If a broker – someone who might be a custodian of a stock trader’s account – can manipulate the market so that buying is cut off, what chance do any of us have? 

Doge this!

Another investment that took off after WallStreetBets touted it was Dogecoin, running from less than a penny up to seven cents. A coin created as a joke might just be letting us all know that the value of money and everything else is just that; a joke. Dogecoin is a cryptocurrency featuring the likeness of the Shiba Inu dog from the “Doge” Internet meme as its logo. Then there is the highly irreverent “Useless Ethereum Token” (or UET as those in the industry like to call it). There is an honesty to the market that is refreshing.

The UET token website advised people away: “Seriously, don’t buy these tokens,” screamed the main page. It also added, somewhat sarcastically, “You’re going to give some random person on the internet money, and they’re going to take it and go buy stuff with it. Probably electronics, to be honest. Maybe even a big-screen television.” Another warning pulled no punches: “But remember—this is a completely honest ICO, which means I don’t want anyone to mistakenly expect the value of the tokens to go up, either. They’re called Useless Ethereum Tokens for a reason.” Surprisingly, they raised $300,000. Perhaps the market was rewarding both the freshness and honesty of the message. Or maybe some billionaire hedge fund manager who got rich on a lucky leveraged to the hilt ‘investment’, AKA a gambling bet on a financial instrument, found the pitch amusing and wanted to financially reward a person he recognized as a fellow traveler of the irreverent investing kind? Oscar Wilde would have enjoyed a character like this, and maybe he’d revise his quote for perhaps a cynic is really a man who knows that price really does mean nothing.