Reddit users who have been pushing up shares of GameStop to crash Wall Street hedge funds are playing an age old game that goes back to 17th century’s “Tulip Mania.”
Back then, investors engaged in wild speculation bidding up the price of tulip bulbs. After rising to extraordinary levels, prices dramatically collapsed.
Although the GameStop frenzy doesn’t quite fit the classic definition, for all intents and purposes, it fits the pattern of a zero-sum game in which losers will far out-number winners.
As Newton once said, whatever goes up, must come down. That’s an inherent truth about GameStop’s stock. There is no intrinsic value in the company to support lofty stock valuations.
Wall Street hedge funds that practice a “long-short” investing style have been shorting the stock for years with good reason.
GameStop is a brick and mortar company in a digital age. It’s a dinosaur that is destined to go the same way as retail music stores like Tower Records and video stores like Blockbuster.
There’s no need to buy physical product like records, movies or video games when they can be far more easily and efficiently downloaded.
Initially, according to reports, traders who frequent such online forums as r/WallStreetBets made their first move on the stock because they saw some value in the company that hedge funds were overlooking.
They contend that e-commerce, mobile gaming and streaming could reverse the company’s fortunes. It has lost money in five of the past six quarters, on a 30 percent decline in revenue in its most recently quarter, according to The Washington Post.
But the stock play quickly morphed into a game of let’s screw Wall Street. Early buyers exhorted others to go in on the stock, driving up the price.
GameStop shot up from a market value of about $2 billion to as much as $24 billion in a matter of weeks.
Some Wall Street hedge funds that were short on the stock were forced to scramble to cover their positions. That pushed prices even higher.
Hedge fund Melvin Capital, for example, was caught with its pants down. It needed a $2.75 billion cash infuson from another hedge fund last week after it lost about 30 percent of its investment.
Meanwhile, the soaring stock price minted dozens of millionaires overnight– for those smart enough to temper their greed and cash out.
The frenzy is also somewhat akin to a pyramid scheme. Each early participants recruit new investors, then cash out on the proceeds.
The number of investors has to increase exponentially to sustain the scheme, or it collapses of its own weight.
Early investors like Keith Gill, known as “DeepF–kingValue” on Reddit, first invested $53,000 into GameStop in June 2019, when shares were around $5. When the stock took off, he told The Wall Street Journal he was making as much as $20 million a day.
He eventually said his fortune hit $53 million when the stock hit its peak. It’s backed off that price now, but he’s still a multi-millionaire and still riding the stock.
Others who jumped into the fray later still racked up impressive gains, just like those who get in early on a pyramid scheme.
To keep the price stable or rising, hundreds of new investors must be recruited. But eventually like other stock bubbles, the price will crash and hundreds, or thousands, of investors will be left holding the bag.
Now, the play is moving on to other Wall Street dogs like movie company AMC, hit hard by the pandemic, and tech company BlackBerry, outmaneuvered by tech rivals.
Much of the trading has been taking place on Robinhood, an app that allows commission-free trading.
When things started getting out of hand, the app and other online sites like Schwab, TD Ameritrade and WeBull tried to snap the wild speculation by restricting trading.
In retrospect, it will be viewed as a sound move. But at the moment, it has touched off a whole secondary firestorm on Capitol Hill.
New York Democratic Rep. Alexandria Ocasio-Cortez; Rep. Rashida Tlaib, a Michigan Democrat and even hard-right Republican Sen. Ted Cruz called for hearings.
They accused Robinhood of protecting the big Wall Street hedge funds at the expense of small investors. But it was doing just the opposite.
The closest illustration of the GameStop craze is the 17th century Dutch “Tulip Mania.”
Rampant speculation in tulip bulbs drove their price to exorbitant heights fueled by the same “get-rich-quick” frenzy.
Of course, the market dramatically collapsed. Investors were ruined and Dutch commerce suffered a severe shock.
Say what you will about greedy hedge funds, they are run by market experts.
Their positions, although laden with some risk and, therefore, speculative to a degree, are at least based on sound analysis.
Nearly everyone expects the stock to eventually crash. The question is, who’s going to be left holding the bag.
The story of the Tulip Mania resurfaces every so often as a cautionary tale about the perils of market mania.
We’ll undoubtedly be hearing more about it, again, soon.