Opinion

Who is the Cinderella in the GameStop fairy tale?

The market might be having a ball, but this isn't going to end with a prince and a glass slipper

Have you heard about GameStop, the most unlikely debutante at the Wall Street ball?

She's an ugly little duckling of a company: sleepy, declining business, uninspired management, low stock price, thin float (a small number of shares available for purchase). She ought to be a scullery maid — yet here she is, in a fancy dress made by her little helpers, and an unbelievable $20 billion market capitalization, dancing at the ball with the prince himself. Her every turn is a victory for the overlooked and overworked, the shoved-aside and condescended-to of the investing world.

That certainly seems to be what the denizens of the Reddit boards who have boosted the stock to utterly absurd heights think. In mundane reality, they're just engaged in an excess of irrational buying, throwing away their money on something they know is worthless. In their minds, though, they're the little helpers who created something beautiful. By encouraging each other to buy and buy and buy — not because they thought the stock was actually more valuable than Wall Street realized, but precisely because it wasn't — they proved that they could to send an ugly duckling to the ball.

This is pretty much the precise opposite of what the heroes of The Big Short, the book and film about the 2008 financial crisis, did. Those sharp-eyed hedge-fund investors saw Wall Street merrily dancing with trillions of dollars of sub-prime mortgage derivatives, blithe to their corrupt structuring and absurd valuations. So they shorted the whole ballroom, and made a killing. The short-sellers were the heroes of that story because they saw the truth. But the limitation of their heroism was that all they did thereby was make money off the very system that they revealed was built on fraud, while real heroes would have struck a blow for justice against the system itself.

Which is what the GameStop folks and their cheerleaders seem to think they are doing, even comparing themselves to Occupy Wall Street. Not coincidentally, GameStop has been pumped up at least in part with the explicit aim of bankrupting hedge funds that are heavily short the stock. In that sense, GameStop is quite explicitly Cinderella's revenge.

But what kind of revenge is it? The Reddit mob buying the stock don't have a fairy godmother to turn mice into coachmen or pumpkins into carriages. All they have is money — their own money. Irrational buying of a stock can push it up for a while, particularly when it has a thin float and is heavily shorted already; short-sellers forced to cover their losing bets are clearly part of what's driving GameStop's furious rise. Eventually, though, the shorts are covered, the mob runs out of funds, and the stock will rapidly collapse back to something resembling a rational valuation. GameStop's boosters will lose all their money, get sent back to the scullery, and discover that no prince is coming with a glass slipper looking for the foot it fits.

Ah — but at least the hedge funds, those nasty step-sisters, will be humiliated, and that will make it all worth it, right? Not really. Yes, a few hedge funds with large short positions in GameStop may go under — those are the risks of leveraged investing, and any investor who complains should read their disclosures. But those losses aren't gains to GameStop shareholders — unless they sell their shares, and who would buy them? No, the gains will go to the investors who pick up the other assets of those failed hedge funds, which they will have to sell in a panic to meet margin calls. That selling will artificially depress those assets' price, teeing up a tidy profit opportunity for nimble investors with the knowledge and liquidity to buy on cue. Most likely, those investors are other hedge funds or Wall Street firms. Hardly revenge to trade one cruel stepsister for another one.

Reddit's meme-based investors in GameStop seem to think they are doing politics, and observers have compared them to the meme-warriors who pumped up Donald Trump in the 2016 election. But there's a fundamental asymmetry between politics and the stock market. Politics is seasonal, culminating in elections, and if you win, you hold office and wield its power for a term. In a system like that, for better or worse, you really can "pump" an over-valued property over the finish line. The market, though, has no such terminus. The game never stops, and the only way to "win" is to take your chips and leave the table.

If there are ringleaders on Reddit who do that — who engineered the frenzy by encouraging others to buy, and then sell into the frenzy for a tidy profit — then GameStop is just a classic pump-and-dump scheme, like the ones by which Jordan Belfort of The Wolf of Wall Street built his fortune. The only novelty would be its mode of execution through a Reddit channel, and the exploitation of spite rather than greed as the primary motivation. If anyone is doing that, it's already fraudulent and illegal, and prosecutions should be forthcoming.

What if there are no ringleaders, though, no plan, no scheme? Then it really is just a fairy tale they told themselves, a rare instance of auto-fraud. I doubt there is any way to regulate that out of existence, and it probably wouldn't be a great idea to try, since irrational exuberance has ever been the market's lifeblood.

So is there truly no Cinderella in the GameStop story? Well ...

If I were writing the screenplay, my hero would be the CEO of GameStop. At the top of Act I, he'd be confronted by a private equity fund aiming to buy the stock cheap, load the company with debt, squeeze it dry of profits, and leave a bankrupt husk. When suddenly the stock becomes the cause célèbre of a mob of Reddit investors, the CEO would be as surprised as anyone. But his daughter, the company's treasurer, would understand one thing: that mad horde had given him a valuable currency, and with it, a chance to make something of his dying company, and strike a blow for the little guy to boot. And so, before the game actually stopped, he'd buy the private equity fund in an all-stock transaction, acquiring thereby a host of legitimate assets — and an opportunity to relieve those businesses from the crushing weight of their cruel former owners.

That's a fairy tale, too, of course; the SEC would never approve such a transaction, and if it did, running the purchased businesses inefficiently would just make them prey for another vulture fund down the road. But let's get real: What do you think Cinderella would do after the prince found her? Invite all her little helpers to live with her at the palace?

If you believe that, I've got some shares of stock to sell you.

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