You can’t expect to understand the movie if you started watching it after the intermission, so here, let me rewind it for you. In fact, consider what I’m about to tell you as the prequel to our major movie.
Image Credits: thegamerimages
In the year 2000, investors all over the world were looking to generate big profits, but of course, something that had less opportunity to fail. Something called ‘mortgage-backed securities’ checked both boxes. In layperson terms, this was basically mortgages of many people bundled together as one. This was a safe option for two reasons. First, this produced high returns from the interest rates homeowners paid and had a low risk because who didn’t pay their mortgage? Defaulters were not a problem because, in the early 2000s banks were extremely selective and gave mortgages only to people with good credit.
As the housing market seemed so lucrative, more and more investors wanted to buy more of these securities. Hence, we come back to the basics of economics- as demand for these securities rose, lenders raised their supply to match this rise in demand. Or at least tried to do so. To increase the supply, lenders now started making mortgages without verifying income and started offering mortgages to people in such a way that they could afford the initial payments but could not keep up with the future payments. This was new and was called subprime mortgages. What adds depth to our story is that investors were completely unaware of this. So inevitability in 2007, when buyers couldn’t keep up with the mortgage prices and started defaulting- Case two of demand and supply came into action, now houses were back in the market. As supply started increasing and demand fell down. Acting quickly, investors stopped buying these subprime mortgages. The stock market crashed, those bundles of mortgage became worthless, but here is where things get interesting.
Behind the Scenes
Traders for the first time had made bets ‘against’ mortgages, meaning, they would make money, only if the housing market crashed. So yes, while the entire world thought the housing market was omnipotent. Some people were already betting on its downfall. The stock market crashed and all this led to the recession of 2008. The rich got richer and of course, the poor suffered. Our economic pie struggled to keep the poor fed, while the rich owned most of it. But although unethical all of this was completely legal, it didn't matter if it shook up the whole economy, we operate under a ‘free’ and ‘unregulated market’ and anyone can do this completely legally, well… the rich can, the same can't be said for the poor. This leads us back to our major movie of the GameStop stocks.
Technically, it all started in 2019 when a $53,000 investment was made in GameStop (which you might have guessed from the name is basically a video game retailer), now this might not have been suspicious but since GameStop works on a brick and mortar business model (which basically means that it does not sell its products online but, in a store) which is considered as “outdated” it is indeed suspicious why anyone would invest this heavily in it. Many other Redditors noticed that 84% of GameStop stocks were shorted (history mimicking its pattern) all this happened around mid-January 2021. Now the hedge fund (basically a group of people who make profits by short selling) who had invested the $53,000 was, Melvin Capital. Remember this name because it will come up again.
Now, it became quite clear to the members of the subreddit “wallstreetbets” what was happening. So to prevent this the whole community of small investors of Reddit came together, rallied everyone they could and spread the word- to buy as much GameStop stocks as every small investor could, it didn’t matter if it was for $4 or $1500 as long as the entire amateur investor community was together, aggressively buying stocks. So yes naturally the share prices increased and all the people who were betting against GameStop that is, the short-sellers, lost $23.6 billion. Melvin Capital who had invested before, lost 30% of the $12.5 billion, all this to a united subreddit community.
Hedge fund Melvin Capital is down US$4.5 billion after epic squeeze by Reddit traders
Image Credits: Mashable
Now to understand the way this works is, let’s assume the example of Melvin Capital. Melvin Capital “borrows” stocks from a broker and sells them in the market for $100, now as they sold these stocks the price of these stocks will fall as their supply would increase, demand would decrease (so basically manipulating and exploiting the market, because well, it is indeed unregulated), people under their influence will sell their stocks as well and hence the price will fall. We already know that the price is going to decrease (shorting) so let us say they are successful, the price falls to $70 so they buy back their stocks that they had originally sold, and make a profit of $30, they then pays the broker a small interest of let’s say $5 and keeps the rest $25 to themselves, quite neat, but what happens if someone already knew what Melvin Capital was up-to.
So with GameStop when Redditors began buying the same stocks Melvin Capital had put in the market, to short. There weren’t many stocks left for them to return to the broker. This means the demand went up and hence the prices went up too. Now Melvin Capital would have to buy these stocks back from Redditors at a high price, but the Redditors weren’t ready to sell.
Now here is where things get interesting, the rich hedge funds have been manipulating the market for decades treating it like their own little casino, getting away with it because well again, it is legal. But here is where things contradict themselves, after these hedge funds lost money, they demanded- That short selling be made illegal. Something that they themselves have been doing for decades, something that is common practice in the market, illegal.
Anyone who has heard of stocks knows what a risk is and they still took that ‘risk’ until they, didn’t. Now you might think that well just because the hedge-funds demanded it to stop, it wouldn’t actually happen right? But by now you must have understood how everything favours those in power, so yes it was in fact made illegal.
“Robinhood” which is basically an app that makes stock trading and investing accessible to everyone suspended buying of GameStop stocks, only buying not selling. Robinhood went against the very essence of its name. The ideals of modern-day Robinhood lie somewhere else.
Robinhood, Melvin, and Citadel execs expected to testify on GameStop before Congress
Image Credits: cointelegraph
The freeze made little sense, scratch that, it made absolutely zero sense at all. This move faced a lot of heat from politicians from both parties in America. The terms ‘free market’ ‘unregulated market’ applicability depends on the toss of a coin either way if it holds true then only for the poor, if it doesn’t then only for the rich, as we saw in 2008. So what’s the takeaway from this? Is it that the rich will remain rich, or is it showing the power of community rebellion and resistance all of it while sitting in front of your respective screens? I’ll leave that for you to decide.
Abhigya Barthwal (Guest Writer)
Abhigya Barthwal is a first-year Economics student at Hindu College. She is interested in poetry, world politics and the human community around us, she also likes to read independent news.