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GameStop, Short Selling and the “Roaring ’20’s”.

As we enter what some are predicting will be a new Roaring ’20’s, as economies “bounce back” from CovEcon-19, it is instructive to look back to the original “Roaring ’20’s”. As now during the second decade of the 20th Century short selling was one of the sophisticated financial products individuals could speculate with.

If you have not come across short selling it is a kind of financial alchemy that transforms base metal, failing companies into sources of golden profit. This process of transmogrification has the following 3 basic steps.

Step 1 You “borrow” a share in the base company (Base Co) paying a rental fee for it for a fixed period of, say, six months. Assume for this example that the stock market value for a share in Base Co. is £100 when you borrow it. Also assume you pay rent at £0.50p per month for the 6 months therefore total cost of borrowing the share is £3.

Step 2 Immediately sell the share you have borrowed for £100. Now you have cash £100 but no shares, an obligation to pay £3 in rent and to return the share in six months.

Step 3 At the end of the six month period buy a share in Base Co at the prevailing stock market price. This step is where the magic happens… you hope.

What you hope is that the share price will have gone down in the course of the six months so that you can buy the share at less than it was worth when you borrowed and sold it.

Assume you are a clever alchemist and the share at the end of six months has halved in value and therefore only costs £50 to buy. In these circumstances you have made a profit of £47 which is arrived at as follows:    £100 – (£50+£3) = £47 Result “Happy Days!”

Of course, you might be a poor alchemist in which case the value of the share you have to purchase at the end of 6 months may have gone up to say £150. Now you are down on the deal:  £100 – (£150 + £3) =  -£53  Result “Ouch!”

If the share price remains at £100 for the six months you have to go into the market and buy them at that price to give them back so you are £3 down on the deal.

Of course you may have increased your investment in this process by borrowing money and buying more shares. This increases your profit but also your loss depending on whether you are a good or bad alchemist. This has the effect of changing the “Ouch!” into an “Aagh!” and the “Happy Days” into “Yipee aye ay”

“Isn’t all this just like gambling? What commercial benefit does it produce in the real economy?” I hear you ask. My instinct is the answers are “yes” and “none”. If that all sounds on the shady side, consider the following.

Between, September 23 and November 4 in 1929 a Mr AH Wiggins, variously President, Chairman of the board and Chairman of the governing board of the Chase bank on Wall Street short sold 42,506 shares of the bank he was the President, Chairman etc of. He was a successful alchemist as he borrowed and sold ahead of the Wall Street crash and purchased and returned when the shares had fallen significantly in price.

As Chase bank’s shares continued to tumble he acquired another 43,506 of Chase shares from an affiliate of the bank, partly financed by a $6.6m loan from his employer – Chase bank! As the bank’s shares continued to collapse he again repurchased at a much reduced price and made a $4m profit on the transactions.

Mr Wiggins was later questioned about whether he felt it was right as a senior employee of the bank he should make a profit out of speculating in its shares using money loaned to him by the bank. Mr Wiggins answer was that by lending the money to employees and allowing them to speculate in its shares the bank was encouraging its staff to have an “interest” in the company.

When asked whether short selling created the right kind of “interest” in the company he thought it doubtful!

Mr Wiggins story is recounted in JK Galbraith’s incisive and witty analysis of “The Great Crash of 1929”. Reading it you see haw egregious practices of the past have been replaced by egregious practices of the present. The parallels with both 2008 and now are instructive.

The Roaring Twenties were a period of excess with growing inequality, enormous optimism about the benefits of capitalism and the rejection of the need for red tape regulation. If we do have an economic bounce back we just need to remember how those Roaring Twenties ended. We should try not to fall into the same trap.

Whilst there are far more regulatory conditions to be met on short selling now as compared with the original Roaring ‘20’s, the question has to be asked why is it allowed to take place at all? What is the commercial benefit in the real economy?

On the negative side, it certainly does not help target companies if large hedge funds are gambling against their success or even survival. Also it creates “immoral hazard” in that powerful financial interests have a strong motive to undermine the company in whatever way they can and certainly have no interest in its success.

I would welcome explanations of the benefits of short selling. I suppose Schumpeterian capitalists may see short selling as a way to weed out the weak quicker than normal share sales. It perhaps provides a hedging mechanism for large funds to manage their risk exposure to moves in the market.

However, to the extent that large enough funds may be able to create a self-fulfilling prophesy it starts to look like a one way bet which may destroy perfectly good companies who are experiencing a difficult patch.

Short selling looks more like it operates for the participants who play casino capitalism rather than those looking to ensure the efficient allocation of investment. For Wall Street over Main Street.

The events around GameStop shares and Robinhood’s purported desire to democratise finance gives a poke in the eye to the Goliath hedge fund managers and their short selling activities. It is difficult not to derive a certain satisfaction from this. However, it is probably not the best way to reign in value destroying speculation.

The thousands of day traders who have bought the shares of GameStop at over inflated prices are clearly not looking to make money, they are looking to take revenge on those powers which seem to determine much of their future and face little if any risk themselves. I suspect in the mix are a number of very savvy investors who are making money on the upward price of the shares.

The motives of many who are participating in this action are definitely on the money, even if their money is not. The financialisation of the economy has gone on for far too long. Reform is needed and effective regulation of Wall Street must be a part of this. Only the state can ultimately achieve an economic environment driven by values which works for the many and not just the few. The Biden administration has a lot on its plate but this needs to be addressed if the despair that fuels anger and division is to be overcome and unity achieved.

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The Patriot Party of “you know who”

A bit like Lord Voldemort there is a temptation not to mention the name of “you know who” now that he is no longer in office. However he continues to tease his followers with the proposals about setting up a Patriot Party.

If he were to do this it will be interesting to see who wants to join. Hard line supporters like The Proud Boys have recently decried “you know who” as “A Total Failure”. I guess his brave leadership from the Oval Office and the quick disavowal of the violence when legal jeopardy threatened him personally probably alienated quite a few of the extreme right insurgents.

They will have noticed a flood of pardons emanating from the White House but probably felt let down when there were none for them.

Maybe there are others, less extreme, who never signed up to insurrection but think “you know who” was doing a great job and it would be good if he could come back. They might well be keen to sign up to a new party. If they do however they may also be well advised to check the small print of the membership T’s&C’s.

Much like the money raised for the legal battle to prevent the stealing of the vote it is likely that the vast bulk ($250m) of the cash will go into a black hole that reappears somehow in the pocket of “you know who”.

Like his University, the new Party for Patriots will probably deliver the same quality product which resulted in a $25m settlement when students claimed they had been duped by claims about what the University would provide.

Mitch McConnell must be watching all this closely in his assessment of whether action to support the impeachment would lance the boil which “you know who” has become on the fundament of the Republican Party. If he fails to move then a new party may be formed which attracts voters away from the GOP, causing a split that would make presidential success in 2024 tantamount to impossible.

As more and more comes out about those who attacked the Capitol, it is quite possible a substantial amount of support will drain away from “you know who” and those GOP members that supported him.

There is a saying that you should never wrestle with a pig because you both get dirty but the pig likes it. Along similar lines you should never get too close to a pig either because the smell lingers. The Republicans don’t seem to have appreciated this.

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Russia jails Alexei Navalny for 30 days | Financial Times

Two EU countries call for bloc to impose sanctions after poisoned activist is detained at Moscow airport

Source: Russia jails Alexei Navalny for 30 days | Financial Times

 

Northern Comment – Would Russia have done this if Washington were not in lockdown? On the positive side it indicates a real fear of the popularity of Navalny and his ability to mobilise opposition.

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Trump’s Base Shrinking?

The latest Pew Research poll of electors, conducted after the attack on the Capitol, confirms a significantly deteriorating and negative view of president Trump post the election as compared to a stable and positive view of Joe Biden. Those that view Joe Biden’s conduct since the election as “excellent” or “good” have increased from 62% to 64%, whilst those that view his conduct as “only fair” or “poor” have reduced from 37% to 35%.

The numbers for the President however have moved significantly against him, from 31% rating his conduct as “good” or “excellent” to 23%. Whilst those rating his performance as “poor” have increased by 8%.

Looking specifically at the issue of responsibility for the attack on the Capitol, 75% of all voters felt he had “a lot” or “some” responsibility for the violence. Further, even amongst Republicans and those that lean Republican, a majority (52%) felt he had “a lot’ or “some” responsibility.

It is of course true this leaves a very significant minority (46%) of Republican supporters reporting the president as having no responsibility for the actions on the Capitol. So clearly there are large numbers of dedicated Trump supporters who remain faithful. However, these figures show a substantial division within the GOP, one which has the potential to become a major rift. One which, further actions of a very angry and often irrational president, may increase.

All of this suggests it is becoming increasingly urgent for the Republican party leadership to decide whether they want to risk sinking with Donald Trump or swimming away from him. To date they have been frightened because of his base. As evidence emerges his base might be shrinking the “courage” to abandon him may grow.

The problem is that as the base shrinks it becomes more and more concentrated in and represented by a dangerous cocktail of extremists. People whose actions the president has legitimated and encouraged over 4 years. The clearer their extremism becomes the more difficult it will be for the many rank and file Republicans to align with them.

President Trump and the GOP have unleashed a tiger and they are now stuck holding its tail. Its actions may well revert to them and indeed it may end up devouring the party which released it. Vice President Pence and Lyndsey Graham have both felt its hot breath on their neck.

It will take Joe Biden a long while to get that genie back in its bottle and starve it of the wider despair and distrust that decades of political neglect have created amongst the vast majority of Americans.

Joe Biden won the election. It is increasingly clear he is winning the transition. His biggest challenge is to create a winning presidency. A presidency which unites the vast majority of Americans behind policies which provide tangible hope for the future over the divisive despair of the past.

This task is daunting as it means having to address the tectonic plates of economic inequality which structure so many of the problems of the United States. All of those interested in the future of democracy must wish him well and support him.