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The REDDIT Rebellion – Putting the Squeeze on Traditional Capitalism

A group of retail investors banded together last week and took on the Hedge Funds in an act just like David vs. Goliath.  And did so in grand form.

I have had many clients and friends ask me about this and some were wanting to jump into the GameStop play after the fact.  I have written this blog to hopefully clarify what has happened and its many ramifications.

We will start with an excerpt of a simple analogy broadcast Friday 29th by New York Times Columnist Thomas Friedman

It is quite funny.  In fact, here is a quick video link you can watch https://vimeo.com/512291780.

“It is like watching a giant National Geographic nature film.  First, there are people we call Lions “Long Sellers” who notice a Wildebeest hobbling around. We will call the Wildebeest “GameStop stock”.  And of course, the Lions killed and ate the Wildebeest by driving the stock price from $63 to $4 dollars a share. When they did this, they made a fortune.

Then along came the Hyenas.  They are called “Short Sellers”.  They fed off the carcass of the Wildebeest, “GameStop”.  Yet, these are magical Hyenas.  They made the carcass grow 50% larger than it really was.  They did this with leverage.

Soon afterward came the Vultures, “Short Squeezers aka Reddit Army” This is a whole new group.  The Vultures, “Short Squeezers” basically in turn ate the Hyenas.

Now the really smart Vultures ate and flew away when the price hit $400 or so.  The dumb Vultures hung around and kept eating.

The Lions came back and ate the remaining Vultures.  By the way, they are still eating.  The latecomers.

Eventually, when it is said and done the stock will return to the $4 value it had before this all happened.

It is the circle of life, Hakuna Matata baby!”

 

Note:  If you do not understand short selling, there are many videos on YouTube that can explain it to you.

 

In addition to this analogy, I grabbed an excerpt from Tom Sosnoff of TastyTrades.com the same morning.

He was asked, “will Capitalism survive?”

His response follows:

“The retail investor is angry and has been shunned for so long.

What is really happening is we have a younger generation finding investing very intriguing.  Because of this they will accelerate the growth of capitalism and provide massive amounts of liquidity.  Everybody will benefit.

This is the best thing to happen in 3 to 4 decades.  Please understand, you will probably not see the perfect storm of what has happened with GameStop ever again.  There was a disastrous panic to the upside.  (The Reddit Army bought heavily and drove the price up).

The Millennials engagement in finance is transformational for sure.”

 

You may be trying to understand what the furor over Robinhood and its Traders, our Politicians, and Media spun panic is all about.

During the maylay they were limited to being able to buy and to sell freely as they had before.  These restrictions are still being applied today.

There is a lot of speculation as to why they did so.  One faction says the regulators forced them to restrict trading at the behest of the Hedge funds, Politicians and Media take your pick as to which conspirator and theory you would like.  Another group says they were afraid of the risk in clearing the trades for GameStop.

There are many news commentators talking, but they do not really understand what probably happened.  I owned my own broker-dealer and I had a clearing arrangement with a Clearing Firm.  The regulators do enforce restrictions, trading limitations, on risky stocks.  Based on what happened last week, GameStop is most certainly a risky stock.

Robinhood recently established their own Clearing Firm.  This is a revenue source.  In doing so they subjected themselves to more regulation.  A Broker-Dealer, a Clearing Firm, must have a certain level of net capital.  (I know this because I was my own Financial Operation Principal and had to perform the Net Capital calculations on my own firm).  They are required to prove they are liquid and have sufficient net capital to clear the trades within the prescribed two-day settlement date of a trade.  There has been a landslide of trades.

When you are clear trades on a volatile stock such as GameStop, and many of the traders were leveraging themselves, (borrowing money to buy or sell more shares than they have).  The Clearing Firm is placing their Net Capital at risk and in turn putting the firm at risk.

I am on the outside looking in, but I believe the latter explanation is probably closer to the truth.  Instead of the quasi-conspiracy theories running amuck.  I read an article Monday morning that confirms my explanation.  The regulators did indeed increase the clearing deposit by around ten-fold.

Being that Robinhood’s Clearing Firm is new, they probably do not have access to a large amount of capital as would a more seasoned firm like a Fidelity, TD Ameritrade, or a Schwab.  Therefore, Robinhood has limited the number of shares of GameStop and other companies that can be purchased and sold to reduce the amount of additional capital they needed to stay compliant with the Regulators.

With all that has happened, I signed on to the Reddit App to learn more as to what is being said and to determine what they are trying to do.  Without going into any detail, all I can say is WOW!  Not necessarily in a good way though.

Now we have politicians and new casters calling for more regulation, investigations, and prosecution of the Reddit Army of traders.  The reality is, and this is a quote from Steve Forbes over the weekend, “you cannot legislate human nature”.

After listening to the politicians and newscasters for the last few days is sickening.  They have not a clue as to what they are talking about.  The ignorance is rampant.

And here is another take on the same thought.  On Shepard Smith’s newscast over the weekend, he referred to the Reddit Army as Populist Investors.  He referenced the mortgage fraud and the financial crisis that ensued in 2008.

“Why was it legal to package bad loans, sell them for billions, and get bailed out by the government, the taxpayers, when the market fails, but it is not ok when people figure out how to fight back against the hedge funds?  “Oh, we will just eliminate the day trading and not allow buying anything with a high short interest.”

Some fellow advisors and I think this is outrageously funny.  The little guy kicked the shit out of the big guys.  And the big guys are whining about it and expecting their bought and paid for Politicians to put an end to it.  I am listening for the phrase that is always used by Corporate America, “We just want a level playing field”.  Not!  “Give us back our monstrous advantage back now!” is what they really want.

The Hedge Fund Managers, Legislatures, and Media can take this and spin it into anything they want, but I agree with Steve Forbes, “You Cannot Legislate Human Nature”.

Also, since these are individual investors and not licensed securities brokers nor investment advisors, they cannot prosecute them over a law or a rule that does not exist.

They can restrict trade through legislation, but that probably will not solve the problem.

I hope you found this helpful.

 

Corey N. Callaway

Investment Advisors Representative

CFS Advisors, LLC

 

 

 

 

 

 

 

 

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