The rise and fall of GameStop (GME) shares captured the headlines in January. While it exposed the dangers of options trading, it highlighted a more endemic issue: the growing problem of wealth inequality.
GameStop had a significant amount of short positions held by large hedge funds.1 Recognizing this, a group of retail investors, using an online forum, worked together to purchase shares and drive up the price.
First, a Primer on Shorting Stocks
When you short a stock, you must borrow the stock from a broker and then sell it in the open market. Since it is borrowed, in order to exit your position at a later date, you must repurchase the stock to return it to the broker. If the share price declines in value, you have made a profit. If the share price increases, you suffer a loss. The higher the price, the greater the loss.
With GME, as retail investors purchased shares to drive up the price, those holding short positions needed to repurchase the shares to exit their positions and minimize their losses, which further pushed the stock price higher. Before long, the GME share price jumped from US$17 to $347, in what is called a “short squeeze.”
Does This Signal a Problem with Financial Markets?
Some have questioned whether the financial markets can effectively function when stock movements become so disconnected from fundamentals. But let’s not forget that, over time, markets have always attracted speculation resulting in temporary periods of inefficiency.
Individual investors are far from the point where they are disrupting the main purpose of equity markets: to help companies raise capital. Traders today do have a greater ability to influence stock market movements — retail order flows have reached 20 percent of the U.S. stock market’s total, twice what they were in 2010.2 Yet, it is unlikely that the players creating large intraday movements for single securities can have the same impact on the overall market.
A Problem: The Rise of Populism & Stock Market Inequity
However, the GameStop situation has highlighted a more pervasive issue. Some have compared it to the Occupy Wall Street movement, representing a generation that feels left behind. 3 Income inequality is at significant highs. No more is this evident than in the stock market. Consider that the top 20 percent of earners own nearly all the stocks held by U.S. households.
Well-respected economist Jeff Rubin confronts these realities in his book, The Expendables, suggesting that we now stand at the edge of a “cliff” created after sacrificing our middle class and outsourcing production and jobs to low-cost China. The economic consequences stemming from the pandemic have only made this inequality worse. The anger from the GameStop situation has been palpable, and it is not likely to end here.
1 By some accounts, approximately 140 percent of the public float had been sold short
2 Bird, Mike. “Day Traders Won’t Sack Wall Street,” The Wall Street Journal. January 27, 2021.