Tl;dr: the retail investor GameStop action may cause the collapse of the stock market, is there truth to this? And if so, what should we do about it?
Ok, so my ass with limited knowledge of markets met with my buddy who trades for a living to discuss what’s going on. Here’s a take that might interest us:
What’s going on is multiple liquidity problems caused by over leveraged everything (sound familiar), occurring at an unstable moment economically. There’s huge systemic risks right now, and basically the Meme stonk push could crash the entire market.
So you have one problem, which is Robinhood. Their CEO basically gave it away on tv when he said that they had to restrict buying because of volatility. Brokers have to maintain enough capital to process payouts from potential sales, similar to a bank that lends, they should e to maintain a certain amount of cash in order to process trading. So every time someone buys a stock, that number goes up. Robinhood doesn’t have the cash on hand to handle the influx of retail traders buying stocks, especially as the price of these stocks skyrocket. They are on the hook for billions of dollars if everybody sold.
They received an emergency cash injection of a billion dollars last night by their private investors, but still are restricting stocks.
IF they run out of money and cannot pay out sellers/maintain deposits, they essentially break or fail. In this situation, the SEC takes over, liquidates (sells) every position in everyone’s account and eventually gives that money back. However, that triggers a massive sell off all over the market, and could trigger a panic selling frenzy (and the market is over leveraged meaning there isn’t enough cash anywhere to pay out).
The other problem is the short squeeze. As you probably know, several hedge funds have made naked short sells on stocks like gme (basically they bet using stocks that don’t actually exist). This is illegal, but also common. What is uncommon is that retail investors noticed, and bought like crazy. Now the price is so high, the shorts will cause insane losses. They have to buy shares at the current price, which costs a huge amount of money, losses in the billions. And since there are more shares they have to buy than exist to be sold, it will drive the price higher and higher as they buy every share available.
They can hold off on buying to get out of their shorts, but this costs interest. Which, due to how underwater they are, is high. Billions of dollars high. Eventually they will have to exit, causing the squeeze.
The problem with that? They don’t have enough money to get out. They are insanely over leveraged. They’ll have to sell every other asset to pay this off, causing a broad market crash, and even then, it might not be enough. Then that loss must be covered by their bank, and if they don’t have the liquidity to absorb the loss…it’s 08 all over again.
But here’s why this is a huge problem for capital. Robinhood could fail if the gme price continues to remain this volatile, and it will if the hedge funds don’t exit their position. And if the hedge funds give in and exit, causes the above. So basically, there’s a liquidity trap coming one way or another, and not a lot of options to avoid it.
That’s why the broader markets have been selling this week. Very dangerous situation either way.
And key differences between this and 08: voters don’t have any electoral means to give their opinion for a few years, populist anger in all directions is very very high but banks and billionaires have attracted near universal ire, the fed has far fewer tools for what would be a much bigger bubble, and the pandemic makes any speedy economic recovery nearly hopeless. All adds up to extreme risk, and obviously a lot of suffering on the line.
Sorry for the long post, but I’m curious if anyone here has any thoughts about this or what we can do in this moment. Is this incorrect?
Here's something I don't understand. Why would anyone have taken the opposite side of a short contract? If I understand this, in a short contract, person A will get money from person B and promise B that they will give them a share at a later date. Since with Gamestop anyone would expect its value to decrease, why would person B take this deal? Because for everyone who shorts a stock there must be someone who agrees to pay to have that stock at a later date, right?
What you're talking about in called borrowing. The rates on this borrowing have gone insane (somewhere above 40% yearly, iirc?) and supply has dwindled. In other words: If I want to borrow one GME share on the open market, I'm going to be high paying fees continuously. The reason those shares are available to borrow isn't necessarily because individual investors consider it sane to allow borrowing, but because brokers generally do this on margin accounts (accounts where you can use some level of credit to trade more quickly or increase your leverage) for additional income.
So in order to short a stock, I borrow it from someone else, sell it, and then buy it back when it's time to return what I borrowed? The person who lends it makes money because the borrower pays a fee then. So neither party loses money, right? The lender got a fee and still has the stock, while the borrower made money on the difference in stock price. But someone must be losing money in this deal. I guess thats whoever bought the share that went on to lose value, right? Because these people are making money without actually producing anything, someone must be losing money...
correct A and B don’t lose - it’s group C, all the stock holders with stocks that plummeted
edit - and group A might have net lost, if their stock loss was greater than their loan interest gain
...and B might lose if A goes bankrupt.