The GameStop Corp (NYSE: GME) saga has brought the world’s attention to the ethics of hedge funds and their ability to short businesses into oblivion. On the other hand, it has also awoken Wall Street to the immense power communities like WallStreetBets on Reddit can wield. The debate continues to heat up over whether retail investors or hedge funds are in the wrong.
Don’t hate the player, hate the game
Hedge funds, Melvin Capital Management, and Citron Research have experienced substantial losses over the last few days as they covered their losing Gamestop short bets. As reported in Business Insider, Melvin Capital required an injection of capital from other hedge funds, totalling US$2.75 billion, to bail out the fund. Melvin will now have an obligation to share its future revenue with those that have supported it.
Some people are infuriated that a small community of ‘inexperienced investors’ could be allowed to conduct this level of price manipulation. However, there are many that have the polar opposite opinion – and instead, see this as hedge funds getting a taste of their own medicine.
Successful venture capitalist Chamath Palihapitiya appeared in an interview on CNBC this week. Host, Scott Wapner suggested that companies should exist based on their earnings. Chamath seemed to be in disbelief of this ‘right price’ notion, commenting:
Who says that? Do you want to make the same argument for Tesla? It’s gone 10X in a few months. You don’t know what it’s worth, let’s be honest. I have my own model for the company – I’m allowed to underwrite however I want to own it.
Chamath continued to outline the hypocrisy between the case being made for Wall Street hedge funds versus retail investors:
Everyone who bought that stock is also underwriting how they want to own it – and the point is, just because you’re wrong, doesn’t mean you get to change the rules. Especially when you [hedge funds] were wrong, you got bailed out the last time. That’s not fair.
Don’t discount GameStop retail investors
There has been this notion that people in the WallStreetBets community, and retail investors in general for that matter, are unequipped to make sound investing decisions. Chamath wanted to dismantle this idea after Mr Wapner made this statement:
It will be a retail investor who gets screwed because they think that this is the way this game works – that this is the new Wall Street. They’re new to this game, maybe they haven’t been in the game that long.
Chamath rebutted this, cautioning not to discount how smart a lot of these people are. The case being made is that the stock market is a free market. The rules are defined, and retail investors citing an opportunity in an over-leveraged short position and playing against that in no way lessens the professionalism of the strategy.
Could the free market become not so free?
This whole situation has become a contentious topic, amplified by a couple of significant recent developments. The first being brokers, including Robinhood and Interactive brokers, have imposed restrictions on trading some of these short-squeezed shares. The stipulation only allows positions to be exited.
Secondly, Discord, a chat platform used by WallStreetBets, temporarily removed the group; effectively eliminating the community’s ability to coordinate.
Since these actions, the GameStop share price has sunk 59%, from $469 to $193 in one day. This begs the question, could this be market manipulation in itself? It is worth noting that the brokerage fee-free Robinhood makes revenue from selling its customers’ order flows to hedge funds like Citadel (which funded Melvin Capital).
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Mitchell Lawler owns shares of Tesla. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and recommends Tesla. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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