By Tony Jiao, Staff Writer
Do you remember Gamestop?
That’s right, that store we used to go to when we were children to buy our Nintendo DS games. Or maybe, if you were lucky, Xbox or Playstation games.
Where are they now? The answer of ‘in the centre of illegal securities fraud and an online investment revolution’ likely doesn’t come to mind. And yet, that is where we find ourselves now, almost a year after the legendary price spike in GME in late January. So, what happened? Why are thousands, if not millions, of investors flooding to a seemingly dying business? What caused the price to skyrocket over 1600% in the last year?
The secret ingredient, as it often turns out to be, is crime. First, we should be familiar with one crucial centrepiece of the entire puzzle: short selling. Typically, a short sale is conducted when an investor, seeing downward price action on the horizon, chooses to borrow shares of a stock to sell, with promises to repurchase and return that stock at a later date (hopefully at a lower price). There is nothing inherently harmful with this type of transaction. It offers investors another tool in their arsenal; in proper terms: it helps markets with proper “price discovery”, by giving pessimistic investors an additional option to bet against their least favourite stocks.
However, large financial institutions can pervert this principle by adding a twist to the sale in what’s known as a “naked short sale”. In naked short selling, you still sell shares of a stock that you don’t technically own, except you haven’t actually figured who you’re borrowing from yet. It’s like a car salesman giving out 10 keys to the same 2021 Ford F-150 parked in his lot to 10 different customers, who are all expecting to be able to drive a shiny new truck off the lot by the end of the day. Naturally, naked short selling is banned in the United States and in many other countries around the world, but that hasn’t stopped many of the world’s largest financial institutions from partaking in it. In GameStop’s case, this happened to an almost comical degree.
At its peak, GameStop’s short interest had reached 115% of the float. Typically, short interest expressed as a percentage of the float indicates how many shares are still owed by short sellers, as a proportion of the total number of shares in the market. The problem quickly becomes apparent when one realizes that this number should never exceed 100%, and yet GameStop regularly reached above that level. The only possible explanation for this is that rampant naked short selling took place, with an insulting lack of effort to even hide the crime.
How does this factor into the online trading craze? Traders from Reddit, specifically the communities r/wallstreetbets and r/superstonk are betting on a single thing: a “short squeeze”. During a short squeeze, investors that have sold shares short are forced to close their positions by the entity whose shares they have borrowed by buying the owed shares back at the current market price. This naturally leads to a sudden, extreme increase in price due to abnormally high buying pressure that can be highly profitable. However, in GameStop’s case, it may not just be lucrative; it may be game changing.
Let’s revisit the car dealership scenario: what happens when the legal owners of those nonexistent trucks begin growing anxious at the end of the day, and demand to see their vehicles? The car salesman would be in a very tricky spot. He has no choice but to cross the street to the other dealership to buy up all of their available trucks. The dealership across the street, sensing the dealer’s distress, decides to sell him the trucks for a much higher price, and our poor salesman has to bite the bullet to accept his losses. However, what if the car salesman had sold more keys to 2021 Ford F-150s than Ford had ever produced? What would he do then? It is a question that we have yet to find out. But one thing is certain: the result of such an event will be felt across the entire market, as large financial firms suffer catastrophic losses and are forced to sell their other assets, causing a marketwide downturn.
Photo by Michael Förtsch on Unsplash
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