Reader vlade was troubled by the widespread misperceptions and conspiracy theories that kept cropping up in comments on his post on the GameStop short squeeze, which sadly is a reflection of how terrible the reporting has been. He thought it made sense to debunk these bogus beliefs in a separate piece.
By vlade, Naked Capitalism’s longest-tenured commentor
1. It was the small guys versus Wall Street!
No, it wasn’t.
At best, it was the small guys igniting a rocket aimed at a few hedge funds.
Hedge funds make a small ($2-$3 trillion) part of the asset management industry ($40 trillion in the US alone). That, in turn, is just a part of the financial industry, which also includes brokers, banks, investment banks etc. etc.
Many of those players almost certainly made out like bandits from of the retail frenzy around GME and others.
And the hedge fund industry has been shrinking for the last six years as investors have been walking away from their high fees and mediocre returns. CalPERS renunciation of hedge funds in 2014 did vastly more damage to the industry than these shorts did by making it OK for big fiduciaries to just say no.
And, in a final irony, almost certainly some hedge funds will have made money from shorting the stock from its 500+ heights down.
2. It can’t be legal to short 140% of the float!
No, it’s perfectly legal.
From Matt Levine at Bloomberg:
This does not necessarily mean a lot of people are doing evil illegal nefarious naked shorting! Really, I promise! There is no special limit on shorting at 100% of shares outstanding! Here is an explanation of how options market makers (discussed below) are allowed to short without a locate, but I want to offer an even simpler explanation. There are 100 shares. A owns 90 of them, B owns 10. A lends her 90 shares to C, who shorts them all to D. Now A owns 90 shares, B owns 10 and D owns 90—there are 100 shares outstanding, but 190 shares show up on ownership lists. (The accounts balance because C owes 90 shares to A, giving C, in a sense, negative 90 shares.) Short interest is 90 shares out of 100 outstanding. Now D lends her 90 shares to E, who shorts them all to F. Now A owns 90, B 10, D 90 and F 90, for a total of 280 shares. Short interest is 180 shares out of 100 outstanding. No problem! No big deal! You can just keep re-borrowing the shares. F can lend them to G! It’s fine.
A note: when A lends the shares to C, the technical ownership in the register will change, the register will still have only 100 shares. But C owes to A all material benefits of owning the share like dividends etc.. The only right lost is the right to vote the share, and most investors don’t do it anyways. For all terms and purposes, A still owns the share, and her broker treats her account as if she did.
If she decides to sell her shares, C is obliged to immediately return the shares.
3. Shorters do naked shorts all the time!
No, they don’t.
Naked short is when the short-seller fails to deliver a share to the buyer. It is illegal to do knowingly, but as it can still happen under some circumstances, proving intent can be hard.
It’s easy to compare a number of fails vs the total short position – if shorts were doing it all the time, there would have to be a lot of fails, especially since a “naked short” position can last at most a few days, because when the fail happens, the failing party is told to immediately cure it. So for a short position of 140%, there would have to be daily fails in tens of percents of the float. Shorts take on a lot (much more than longs) of risk already, taking on this kind of legal risk for no gain would be beyond idiotic.
4. Shorters drive companies to bankruptcy!
No, they don’t. Companies drive themselves to bankruptcy.
Think about it. Bankruptcy is when someone cannot pay their liabilities. Equity is defined as a difference between assets and liabilities. What value is placed on the equity by the public markets does not make a difference to the real assets and liabilities.
The stock prices makes NO DIFFERENCE to most companies at almost all times. The proof is extremely easy – most of the world’s companies are private, they don’t have any well defined stock price if they have any, yet they operate and operated for centuries.
The only companies that care about their stock price are banks and other big financial firm, because they are borrowing short and sometimes longer term all the time, and if their credit rating are weak or start to fall, they could have trouble rolling their debt or extending its maturity unless they sell more stock, which they will not want to do if their stock is in the crapper. More simply, their stock is their “inventory” of capital, and they need capital to operate.
The stock price also matters vastly to the management of the public companies, which is why they get very cross with shorters.
But I hear you say “what about the ability to raise money?”. Most companies would raise debt. Private companies have no public shares, yet raise the debt – because the bank is looking at the cashflows and existing assets and liabilities, not their share price.
Yes, the companies may go to the exchange to raise money. But I’m very sure that a company with undervalued shares because of a short attack would have investors queuing for discounted share issue – as long as the company itself was healthy.
Shorters do not short obviously healthy companies, same way as predators won’t go for the strongest one in a herd voluntarily.
5. Robinhood was told to stop accepting orders to protect hedge hunds!
No, it wasn’t.
Neither by Citadel to protect its loan to Melvin, nor by anyone else.
Because the US stocks are settled at T+2 basis, there is a credit risk both to the buyer and seller. To deal with that, the clearers/exchanges (in this case DTCC as the clearing house) set a margin requirement – for the broker. It is not a margin for the final users – you can vaguely think of DTCC as brokers’ broker.
The margin is set based on the stock volatility, and GME had recently volatility >500%, which is YUUUGE. As a result, DTCC increased its margin on these stock from 1%-3% to 100%.
If Citadel told Robinhood to stop, officially or not, Robinhood would make a killing in a lawsuit. Wall Street is dog-eat-dog, and firms sue themselves to death all the time.
6. DTCC raised only Robinhood’s margin!
No, it didn’t. It was raised for every client of DTCC that had settling trades for the equities affected. E-trade stopped, Interactive Brokers stopped…
Robinhood was the worst affected, because they had the largest trade volume in these highly volatile securities. Robinhood itself claims its DTCC margin was increased ten-fold, which given the margin requirement went from 30 to 100 times, tells you the massive amounts of trading pushed through them on these stocks.
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Thank you Vlade and Yves. It seems like maybe this was pretty much just like the “Storming of the Capitol”, just more internet conspiracies to drive people into a frenzy to do something that only benefits a few people and leaves the majority holding the bag.
“QAnon for stock traders” is the truth!
That is indeed my (and I believe Yves’) point.
QAnon for stock traders is fairly accurate.
I have spent some time (too much) reading twitter feeds and stock message boards and one thing that struck me was the constant moving of dates when the stocks were going to go “to the moon.”
First it was Friday when options expire, then Saturday or Monday when they have to be settled. It is similar to the QAnon dates of Jan 6 then Jan 20, now the focus is on March 4 for some reason.
It is almost a con to keep pulling people in by dangling yet another lantern further and further down the darkening tunnel.
On a side note. When my college-aged day daughter asked if she should invest to “stick it to the man”, I told her the “man” would be happy to sell to you.
Not to mention that message boards like Reddit are anonymous. Financial firms could hire an army of interns (maybe with an organizational/legal firewall in place) for pennies to spread rumors and otherwise talk right out of their rear ends.
Wow, thank you for this primer. I got caught up in the hype but never bought. It got fishy. I watched people throwing money into the GME pit while that one Korean fund walked away with a clean billion dollars. I had a feeling something was up.
To point 1, though, People were absolutely convinced that by buying stock they were sticking it to the man.
Feels a lot like throwing your steak dinner into the shark tank and declaring that overeating is going to kill the sharks.
This is probably the best simile I heard on it so far – mind if I steal it?
It’s all yours vlade! You’re doing good work and if a simile will help, by all means.
Thought vlade might be interested to know that someone from WSB sent the following letter to the SEC a month ago:
https://www.reddit.com/r/wallstreetbets/comments/kr98ym/gme_gang_we_need_to_complain_about_naked_short/
– if someone was rolling their short position, it would mean continuous fails. They would get noticed, it’s suspicious.
– even if it wasn’t noticed, the average numbers across Dec and Jan are less than 1m, a small fraction of the float, and even smaller fraction of the short interest, so there’s no way it could have explained anywhere close the the total short interest.
– as Levine links to (https://nope-its-lily.medium.com/gamestop-power-to-the-market-players-part-1-d8863f2f8604 – this is actually a very good post, for example has some data imply that Melvin was actually doing what I said, use put options for almost all their short, which would imply that on GME they lost pennies compared to AUM *) **), option makers are exempted from locate rules, and hence can naked-short. There was a frisky market in the GME options, almost certainly leading to fails.
So yes, _somone_ might have been shorting GME via illegal naked shorts. I never said no-one did (although FTDs can . But it’s likely to be a trivial part, especially if we take into account the options.
If SEC was any good, and had interest in transparency (hahaha), it would look into this, and publish some breakdown on the source of the fails, if for nothing else, just to show that shorts weren’t (much if at all) doing it illegally.
Incidentally, a bit of fun I found when looking at the SEC data: A symbol GMEV (which vaguely looks like GME) had MASSIVE fail-to-deliver numbers in January. 50m shares on Jan 11. Mind you, it’s a pink-sheet stock with price not even in pennies (right now 0.26c). It also had a massive – like 300% spike on January 26.
*) if Melvin (and others) had a massive short put position, that, due to the delta hedging, would have actually implied that the beneficial short position was even larger than 140%.
**) although further down has some rebutals so it may look that Melvin had a combination of outrights and puts after all.
The Melvin situation is a bit confusing, and I’m too busy to go looking for some good numbers. WSJ reports they lost ~5bln. That’s a lot of GME stock – we’re talking close to 20% of the stock float at least.
If those loses were mostly GME related, then Melvin deserved what it got – and more. But it’s possible it was caught in a number of positions – which would, on the other hand, indicate Melvin as a selected targed (or again, Melvin just being even more stoopid, and momentum following favoured shorts w/o having any clue what it meant).
Just noticed there is an error in the letter. GME has 69.75m shares outstanding, which means 0.05% of GME shares is approx 35k shares, not 350k. That means 1m shares is approx 1.4% of the float.
Only 6 myths? This could easily be expanded into dozens. Very early in my blogging life I had to learn the hard way that the stock market doesn’t matter. Indeed, this whole frenzy doesn’t make any sense until you remember that. And if it doesn’t mater, why “invest” in the stock market at all? It’s the busting of this myth that has Wall Street worried.
Thanks Vlade!
I guess I would have been prime fodder to be in the stock biz, using my dad’s connections to be part of the 3-letter-monte game, but i’m so glad it never had any appeal. It seems like a digital layer cake of subterfuge with a creamy filling of deceit.
Thanks. I think naked short may have more than one use – we always used it for positions that were completed unhedged, not the circumstances you describe. Otherwise good work!
As the link in Matt Levine’s comments says, market makers are allowed to naked short – regulation SHO, which if you read, says “Thus, market makers must sell a security to a buyer even when there are temporary shortages of that security available in the market. This may occur, for example, if there is a sudden surge in buying interest in that security, or if few investors are selling the security at that time. Because it may take a market maker considerable time to purchase or arrange to borrow the security, a market maker engaged in bona fide market making, particularly in a fast-moving market, may need to sell the security short without having arranged to borrow shares.”
GME was, by most people’s measure “fast moving market” recently.
I heartily recomment the link in Levine’s description, it has a few things I didn’t read about before (TBH, I can’t be bothered to look into this into so much detail when so many bigger things are misunderstood repeatedly).
Ta. Placed in that context, the definition isn’t that far away from the one we used.
I thoroughly understand your desire to not look into this too much – I too have things to look at that seem more relevant!
Thanks for this. It’s disappointing that so many people have bought into this being some sort of revolution, but (as I never tire of telling everyone I know who tries dabbling in the markets), you will simply not beat the pros at their own game.
No, you beat the pros by buying boring index funds (0.05% expense ratio) and waiting 30 years. All this trading talk hides how to “win” in the stock market. You win by buying everything and waiting. Waiting. Waiting… very boring really. So boring, most people can’t do it.
Me ? Still waiting. 10-15 more years worth of it. Don’t bother to wake me up. I’m fine waiting.
Time is the one thing the retail investor has an even playing field with the pro’s.
It’s not boring when it’s all in freefall, as happens at increasingly regular intervals. You can bet all those stupid traders (who would have gotten out mostly whole) will be not be the one’s kicking themselves if (when?) one of those crashes ever “sticks the landing” for some reason.
Read a book about trend following, before writing them all off. Plenty of people are making very good livings out of it, although you need enough money to start with!
Thats interesting that someone can borrow a share to short, and then lend to someone else to short. Sounds exactly like the fractional reserve system we have in banking.
Thanks–that helps me conceptualize what’s going on
No. You borrow to short and then sell. The new buyer can re-lend the share.
And we do not have fractional reserve banking system neither (althought you are correct that the the share borrow/sell does work similar to how a fractional reserve banking system is described, except w/o the reserve)
Mohammed El-Erian commented yesterday, in context of discussing equity price declines due to funds selling long positions to cover shorts, that we had avoided a market accident. And went on to discuss risks in excessive use of leverage. That seems like the real story.
Can’t help noting that as far as I could see the WSB crowd were not at all basing what they did on a belief that the shorters were wrong in their evaluation of the stock’s value. (and from the resumed steady deterioration of the price, they were not.) Nor did they care. Had they, there’d really be no story other than a perfectly normal pricing mechanism in operation.
I doubt the people involved will really make a habit of this variety of high-stakes gambling. If they do, it will be a short-lived habit, as its unlikely most of them are able to absorb the losses on the inevitable failures.
RE: https://www.theatlantic.com/ideas/archive/2021/02/gamestop-story-you-think-you-know-wrong/617905/
I have a post that immediately went to moderation. This article, which I JUST clicked on talks about the some of the same things.
The fear around this thing is palpable…
Just one quick note on the article above that I just found. It says
“Larger brokerages, such as Charles Schwab, didn’t pause buying in the same way.”
“In the same way” is doing a lot of work there.
The site was all over where they could buy without any restrictions during the heat of it all a few days/week ago…and mainly it was only Fidelity and Vanguard in the USA that passed their test.
All places where most of the reddit crowd would not have their accounts and have deep pockets for margin calls.
You can manipulate share prices.
CEO’s worked it out ages ago.
As a CEO, I can use the company’s money to do share buybacks, to boost the share price; get my bonus and top dollar for my shares.
What is there not to like?
Share buybacks were found to be a cause of the 1929 crash and made illegal in the 1930s.
What lifted US stocks to 1929 levels in 1929?
Margin lending and share buybacks.
What lifted US stocks to 1929 levels in 2019?
Margin lending and share buybacks.
A former US congressman has been looking at the data.
https://www.youtube.com/watch?v=7zu3SgXx3q4
Margin lending can inflate share prices too.
The University of Chicago worked that out in the 1930s.
What is the fundamental flaw in the free market theory of neoclassical economics?
The University of Chicago worked that out in the 1930s after last time.
Henry Simons was a founder member of the Chicago School of Economics and he had worked out what was wrong with his beliefs in free markets in the 1930s.
Banks can inflate asset prices with the money they create from bank loans.
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
Henry Simons and Irving Fisher supported the Chicago Plan to take away the bankers ability to create money.
“Simons envisioned banks that would have a choice of two types of holdings: long-term bonds and cash. Simultaneously, they would hold increased reserves, up to 100%. Simons saw this as beneficial in that its ultimate consequences would be the prevention of “bank-financed inflation of securities and real estate” through the leveraged creation of secondary forms of money.”
https://www.newworldencyclopedia.org/entry/Henry_Calvert_Simons
Margin lending had inflated the US stock market to ridiculous levels.
Real estate lending was actually the biggest problem lending category leading to 1929.
Richard Vague had noticed real estate lending balloon from 5 trillion to 10 trillion from 2001 – 2007 and went back to look at the data before 1929.
The Americans did real estate in 2008, now it’s stocks.
The IMF re-visited the Chicago plan after 2008.
https://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf
Watching this unfold has been absolutely fascinating, and what with the pandemic limiting my options, is the best entertainment I’ve had since last March.
What started out as a smart play to squeeze the over-shorted stock of a failing retailer has degenerated into a cult-like atmosphere. Now the bagholders on wsb sound like Qanon.
“Extraordinary Popular Delusions and the Madness of Crowds” was published in 1841 and remains evergreen.
Thanks again Vlade. It is really an organic structure of regulation… “brokers’ brokers” – So it looks like the problem is the Internet – it’s on the public end. Until there are regulations against chatting up a big short squeeze, the SEC is powerless. We probably do need another agency. If we want to make finance democratic. This is way interesting and beyond “consumer protection” for public investment; it goes to the heart of the crazy world we now live in and how best to regulate things that were once considered “freedoms” like the right to free speech. Because, clearly “free speech” isn’t free if it harms other legitimate interests. I think it’s a problem that cannot be solved by the SEC – it will have to be solved by unions. Unions for public investment. Or something like that. With ground rules.
Great post!
Sheila Bair was interviewed and suggested it was about time T+2 was gotten rid of. No need for it anymore and it just adds risk. Interesting times.
I doubt anyone here is playing 3D chess. Both sides of the trade have their narratives and counter narratives.
From Fortune:
“While the DTCC’s activities are an integral element of financial markets, the process by which it assesses risk is not transparent. In his conversation with Musk, Tenev described the process as “opaque.””
“Opaque” adds another layer of uncertainty and no doubt contributed to the volatility of the stock price. Would GME have collapsed again were it not for their intervention?
The battle of influence that occurs behind closed doors could be called corruption in simpler times.
The DTCC rules may be opaque – any risk model is opaque unless you know all imputs.
It’s IMO highly dubious if it would make much difference to RH – I’d have to see a good explanation why. Saying “it’s opaque” doesn’t mean anything. To an extent, I’d be surprised if Tenev knew about it much to start with, as wherever he was before it was dealt on by the boring back office.
RH knew about the existence of the rules. It should have read and understand implications (not that many business do understand the implications of what they sign up to) This clearly falls under operational risk, and if RH ignored it, it may have to pay more money to SEC as its operational risk processes would be clearly broken.I haven’t looked, and don’t have time to, and no-one’s going to pay me to either, but I’m reasonably certain that there were previous examples where DTCC ramped the margin on a particular stock to 100%.
Thanks Vlade. I have a quibble with the example used in the Bloomberg article; i.e., “A lends her 90 shares to C, who shorts them all to D”.
This would seem an outdated example as most ownership is electronic nowadays with the shares being “held” by brokers. I suspect that it is the brokers who are lending the shares and that the underlying owner may not be aware of this or receiving any compensation.
I believe that you have to tick a box (or with some, untick a box), which allows your broker to lend the shares out.
The broker will take a comission on the lending, but the lending money goes to you.