More on the GameStop Short Squeeze: GME Myths Busted
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.
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.