Hedge fund managers are currently learning a lesson the hard way.  As reported by Reuters, hedge fund Melvin Capital Management “suffered heavy losses by betting against video game retailer GameStop.”

Here’s how that happened.  Hedge fund Melvin Capital had opened a large short position (i.e., it sold borrowed stock) on GameStop in hopes that the price would fall and it could buy the stock at a lower price in the future to profit on the difference.  Instead, GameStop’s stock price increased meteorically.  Facing unknown and unlimited risk, the hedge fund had to cut its losses by closing its short positions, i.e., paying a much higher market price for the stock they’d borrowed and sold, thus absorbing heavy losses. 

These losses were so heavy that Melvin Capital had to secure billions in “rescue capital” from other prominent hedge funds, according to the New York Times. These hedge funds are collectively such influential players in the stock market that this event had ripples felt throughout the marketplace, manifesting as a declining market even as GameStop’s stock surged.  As Naeem Aslam at Forbes observes, covering these short positions requires the “liquidation of long positions in hedge funds,” which causes a “broader sell-off” in the market. This type of thing isn’t new, he writes.  “In 1902, we also saw an episode of this when Northern Pacific stock price increased several times while the rest of the market crashed.”

From transcontinental railroads to video game retail stock, there’s not much which has changed about short selling in the marketplace, conceptually.  And right or wrong, there’s always been a public assumption of devious intent applied to anyone engaged in the business of selling short. As Daniel Defoe wrote in The Political History of the Devil (1726), “every dissembler, every false friend, every secret cheat, every bearskin-jobber, has a cloven foot.”  And today, there are few entities more detested among the contemporary public than hedge funds.

Though I personally believe that short sales are a natural and enduring feature of a free marketplace, it’s easy to see why our natural human inclination is to be suspicious of someone who has an economic interest in the failure of another enterprise.  This feeling is only amplified when those seeking the failure of another enterprise for the sake of profit are those who seem to need profit least.

Now, consider this in the context of how the everyday American sees this.  And, more to the point, how two million enterprising young professionals might see this. 

There’s one set of opportunities and regulations for investors with established money and power, and there’s another for everyone else. How could anyone view hedge funds differently?

Wall Street Bets is a Reddit forum comprising well over two million small-dollar, speculative retail investors who are credited with pushing GameStop’s stock price to such heights.  Some users are making it clear that they view this as an expression of their power. 

One user writes, “FOR ALL THE BIG F---ING HEDGE FUNDS MONITORING US, THIS IS A MESSAGE… WE F---ING OWN YOU… GO BUY THE F---ING NEWS.” [sic]

And why wouldn’t the hedge funds be monitoring?  Why wouldn’t they, with all of their power and money, seek retribution through political lobbyists to shut the forum down when their retail investing escapades hit the pocketbook of America’s richest and most politically connected?

The young retail investors don’t seem afraid, though.  Another writes:

To the SEC retards in this sub: go f--- yourself. Why don’t you start investigating why companies can shut down trading so their hedge fund buddies don’t lose money.  But when people lose money it’s completely ok.  Eat a d---.

Note the separation between “hedge-fund buddies” of the market administrators and ostensibly normal “people.”  Again, it’s easy to understand this distinction.  When a hedge fund takes a large short position on GameStop, the hedge fund shareholders only win at the expense of the long-term shareholders and employees of GameStop, some of whom lose their entire positions in the enterprise or their livelihoods.

To be clear, I haven’t fully concluded as to where I stand on all of this. GameStop’s price and massive market capitalization, as of this writing, seems clearly unsubstantiated and practically artificial.  But then, Tesla’s outrageously soaring stock price isn’t based on anything fundamental either, considering it just turned its first profit last year, and missed analysts estimates in doing so. 

A market price is just what people are willing to pay for something, and these young retail investors are putting their money on the table.  And they’re doing it in spite of the fact that they know they’re not supposed to be doing it. 

That’s something.  That’s conviction, at least, if not courage.  That’s people putting skin in a game in which they’re hoping to influence the outcome.  They’re not destroying others’ property in order to demand tax increases for high income earners while paying no income taxes themselves.  And for that alone, I can’t shake this initial feeling of hopefulness.  Something along the lines of Mark Cuban’s read on it:

I got to say I LOVE LOVE what is going on at #wallstreetbets.  All those years of High Frequency Traders front running retail traders, now speed and density of information and retail trading is giving the little guy an edge. Even my 11 yr old traded with them and made $.

We are in the witnessing the beginning of a David and Goliath kind of battle for an incredible amount of money and power.  Naeem Aslam at Forbes seems to understand what’s really going on:

Retail traders have become a significant part of the story and they are effectively telling Wall Street that it is no longer in control of stock prices. Generally speaking, institutional traders such as hedge funds will bet against retail traders. Commission-free trading has started to change the game and since last year, there is no doubt that retail traders have started to gain much more control.

Institutional and accredited investors often seek to profit as retail investors suffer.  Retail investors, recognizing the adversarial relationship that exists, are reciprocating by exercising their collective power in influencing market prices.

The legal escalation of these issues with regulatory bodies, like the SEC, will be interesting to see play out.  Hedge funds and their political surrogates will cry foul, of course.  They’ll claim that millions of middle-class market participants are stacking the deck against institutional market players by unnaturally manipulating prices, or some such. 

What will be most interesting to watch, however, is how the New York Times, MSNBC, and Joe Biden will stumble all over themselves as they completely reverse their position from ten years ago.  Back then, corporate and hedge-fund billionaires were the plague that is decimating America’s poor and middle class.  Today, expect those same voices to defend corporate and hedge-fund billionaires as the bulwarks of a stable market, while supporting the suppression of millions of small-dollar retail investors who seek to exercise their power in the marketplace in the only meaningful way that they can.

Image: Gamestop